Importance of Theory of Effective Demand
The Importance or Significance of Theory of Effective Demand is every bit follows:-
1. Determinants of Employment
Effective Demand determines the grade of employment. When effective need increases occupation likewise increases in addition to when it decreases occupation likewise decreases. According to Keynes, involuntary unemployment tin laissez passer notice live on removed yesteryear raising consumption expenditure in addition to investment expenditure. The same tin laissez passer notice live on achieved yesteryear regime expenditure. Thus, the regulation of effective need is the terra firma of the theory of employment.
2. Invalidates Say's Law of Full Employment
Keynes's theory of occupation rejects the Say's Law of markets stating that "supply creates its ain need in addition to that of full-employment equilibrium."
The regulation points out that nether occupation is a existent situation, in addition to total occupation is an accidental situation. In a free-enterprise economy, furnish fails to exercise its ain demand.
3. Invalidates Pigou's Wage Cut Policy
Prof. Pigou says, "full occupation is attained yesteryear reducing the coin wages."
However, the wage cutting policy of Prof. Pigou is likewise cancelled yesteryear this principle. According to Keynes, reduction inwards coin payoff volition convey downwardly the consumption expenditure on goods in addition to services in that place yesteryear 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 in addition to Investment expenditure. When income increases, consumption expenditure likewise increases only inwards the lesser proportion. Thus in that place is a gap betwixt income in addition to consumption, which leads to a reduction inwards grade of employment. This gap tin laissez passer notice live on filled upwards yesteryear 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 yesteryear aggregate need function, which is composed of consumption expenditure in addition to investment expenditure. The basic regulation is that when income rises consumption likewise rises only inwards lesser proportion. This leads to a gap betwixt income in addition to consumption, which must live on filled upwards yesteryear the required investment expenditure. If sufficient investment is non forth coming to fill upwards up this gap thus it leads to deficiency of effective need resulting inwards unemployment.
In a pitiful country, the gap betwixt income in addition to consumption is minor because the marginal propensity to eat (MPC) is high. Therefore, this gap tin laissez passer notice live on filled upwards yesteryear investment expenditure. There are fewer difficulties inwards employing all its resources to hold an equilibrium grade of income in addition to employment.
In a rich country, the gap betwixt income in addition to consumption is real high because MPC is low. Therefore, it volition take large investment expenditure to fill upwards up the gap betwixt income in addition to consumption inwards lodge to hold the high grade of income in addition to employment. However, inwards a rich country, in that place 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) in addition to depression MPC.
Therefore, investment expenditure fails to fill upwards the gap betwixt income in addition to consumption. This leads to a reduction inwards aggregate need of income in addition to employment. Thus, the downward tendency inwards aggregate need inwards income in addition to occupation may continue. The decline inwards saving becomes equal to investment. The economic scheme attains equilibrium only in that place would live on massive unemployment.
Thus inwards a rich province where in that place are enough of unutilized resources, unemployment in addition to poverty prevail inwards the midst of potential plenty.
