Importance Or Significance Of Theory Of Effective Demand

Importance of Theory of Effective Demand

The Importance or Significance of Theory of Effective Demand is equally follows:-

1. Determinants of Employment

Effective Demand determines the degree of employment. When effective demand increases work besides increases in addition to when it decreases work besides decreases. According to Keynes, involuntary unemployment tin hold out removed past times raising consumption expenditure in addition to investment expenditure. The same tin hold out achieved past times authorities expenditure. Thus, the regulation of effective demand is the footing of the theory of employment.

2. Invalidates Say's Law of Full Employment

Keynes's theory of work rejects the Say's Law of markets stating that "supply creates its ain demand in addition to that of full-employment equilibrium."

The regulation points out that nether work is a existent situation, in addition to total work is an accidental situation. In a free-enterprise economy, provide fails to gain its ain demand.

3. Invalidates Pigou's Wage Cut Policy

Prof. Pigou says, "full work is attained past times reducing the coin wages."

However, the wage cutting policy of Prof. Pigou is besides cancelled past times this principle. According to Keynes, reduction inward coin payoff volition convey downward the consumption expenditure on goods in addition to services in that place past times causing a decline inward the degree of employment.

4. Importance of Investment

The regulation of effective demand is based on aggregate expenditure, i.e. Consumption expenditure in addition to Investment expenditure. When income increases, consumption expenditure besides increases merely inward the lesser proportion. Thus in that place is a gap betwixt income in addition to consumption, which leads to a reduction inward degree of employment. This gap tin hold out filled upwards past times increasing investment expenditure because inward the short-run consumption expenditure remains stable.

5. Paradox of Poverty inward the Midst of Potential Plenty

In a free-enterprise economy, the theory of effective demand explains the paradox of poverty inward the midst of potential plenty. Effective demand is determined past times aggregate demand function, which is composed of consumption expenditure in addition to investment expenditure. The basic regulation is that when income rises consumption besides rises merely inward lesser proportion. This leads to a gap betwixt income in addition to consumption, which must hold out filled upwards past times the required investment expenditure. If sufficient investment is non forth coming to gain total upwards this gap hence it leads to deficiency of effective demand resulting inward unemployment.

In a pitiful country, the gap betwixt income in addition to consumption is modest because the marginal propensity to swallow (MPC) is high. Therefore, this gap tin hold out filled upwards past times investment expenditure. There are fewer difficulties inward employing all its resources to hold an equilibrium degree of income in addition to employment.

In a rich country, the gap betwixt income in addition to consumption is really high because MPC is low. Therefore, it volition demand large investment expenditure to gain total upwards the gap betwixt income in addition to consumption inward gild to hold the high degree of income in addition to employment. However, inward a rich country, in that place is a job of inadequate aggregate demand resulting inward broad unemployment. Further inward such a community inducement to invest is depression due to decline inward marginal efficiency of upper-case alphabetic lineament (MEC) in addition to depression MPC.

Therefore, investment expenditure fails to gain total the gap betwixt income in addition to consumption. This leads to a reduction inward aggregate demand of income in addition to employment. Thus, the downward tendency inward aggregate demand inward income in addition to work may continue. The decline inward saving becomes equal to investment. The economic scheme attains equilibrium merely in that place would hold out massive unemployment.

Thus inward a rich province where in that place are enough of unutilized resources, unemployment in addition to poverty prevail inward the midst of potential plenty.