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 grade of employment. When effective need increases job likewise increases together with when it decreases job likewise decreases. According to Keynes, involuntary unemployment tin live on removed past times raising consumption expenditure together with investment expenditure. The same tin live on achieved past times authorities expenditure. Thus, the regulation of effective need is the Earth of the theory of employment.
2. Invalidates Say's Law of Full Employment
Keynes's theory of job rejects the Say's Law of markets stating that "supply creates its ain need together with that of full-employment equilibrium."
The regulation points out that nether job is a existent situation, together with total job is an accidental situation. In a free-enterprise economy, furnish fails to practise its ain demand.
3. Invalidates Pigou's Wage Cut Policy
Prof. Pigou says, "full job is attained past times reducing the coin wages."
However, the wage cutting policy of Prof. Pigou is likewise cancelled past times this principle. According to Keynes, reduction inwards coin reward volition convey downwards the consumption expenditure on goods together with services at that topographic point past times causing a decline inwards the grade of employment.
4. Importance of Investment
The regulation of effective need is based on aggregate expenditure, i.e. Consumption expenditure together with Investment expenditure. When income increases, consumption expenditure likewise increases exactly inwards the lesser proportion. Thus at that topographic point is a gap betwixt income together with consumption, which leads to a reduction inwards grade of employment. This gap tin live on filled upwardly past times increasing investment expenditure because inwards the short-run consumption expenditure remains stable.
5. Paradox of Poverty inwards the Midst of Potential Plenty
In a free-enterprise economy, the theory of effective need explains the paradox of poverty inwards the midst of potential plenty. Effective need is determined past times aggregate need function, which is composed of consumption expenditure together with investment expenditure. The basic regulation is that when income rises consumption likewise rises exactly inwards lesser proportion. This leads to a gap betwixt income together with consumption, which must live on filled upwardly past times the required investment expenditure. If sufficient investment is non forth coming to fill upwardly up this gap together with thence it leads to deficiency of effective need resulting inwards unemployment.
In a pitiful country, the gap betwixt income together with consumption is minor because the marginal propensity to eat (MPC) is high. Therefore, this gap tin live on filled upwardly past times investment expenditure. There are fewer difficulties inwards employing all its resources to hold an equilibrium grade of income together with employment.
In a rich country, the gap betwixt income together with consumption is rattling high because MPC is low. Therefore, it volition take large investment expenditure to fill upwardly up the gap betwixt income together with consumption inwards fellowship to hold the high grade of income together with employment. However, inwards a rich country, at that topographic point is a job of inadequate aggregate need resulting inwards broad unemployment. Further inwards such a community inducement to invest is depression due to decline inwards marginal efficiency of working capital missive of the alphabet (MEC) together with depression MPC.
Therefore, investment expenditure fails to fill upwardly the gap betwixt income together with consumption. This leads to a reduction inwards aggregate need of income together with employment. Thus, the downward tendency inwards aggregate need inwards income together with job may continue. The decline inwards saving becomes equal to investment. The economic scheme attains equilibrium exactly at that topographic point would live on massive unemployment.
Thus inwards a rich province where at that topographic point are enough of unutilized resources, unemployment together with poverty prevail inwards the midst of potential plenty.
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