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 hold upward removed past times raising consumption expenditure in addition to investment expenditure. The same tin hold upward achieved past times authorities 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 practise its ain demand.
3. Invalidates Pigou's Wage Cut Policy
Prof. Pigou says, "full occupation 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 payoff volition pick out downward the consumption expenditure on goods in addition to services at that spot 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 in addition to Investment expenditure. When income increases, consumption expenditure likewise increases only inwards the lesser proportion. Thus at that spot is a gap betwixt income in addition to consumption, which leads to a reduction inwards grade of employment. This gap tin hold upward filled upward 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 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 hold upward filled upward past times the required investment expenditure. If sufficient investment is non forth coming to fill upward up this gap in addition to then it leads to deficiency of effective need resulting inwards unemployment.
In a misfortunate country, the gap betwixt income in addition to consumption is small-scale because the marginal propensity to swallow (MPC) is high. Therefore, this gap tin hold upward filled upward past times investment expenditure. There are fewer difficulties inwards employing all its resources to keep 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 need large investment expenditure to fill upward up the gap betwixt income in addition to consumption inwards guild to keep the high grade of income in addition to employment. However, inwards a rich country, at that spot 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 uppercase (MEC) in addition to depression MPC.
Therefore, investment expenditure fails to fill upward 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 at that spot would hold upward massive unemployment.
Thus inwards a rich province where at that spot are enough of unutilized resources, unemployment in addition to poverty prevail inwards the midst of potential plenty.
