Effective demand

Effective demand is the level of aggregate demand at which firms’ expected sales make their output and employment plans consistent with buyers’ spending.

Aggregate demand: Aggregate demand is total planned spending on an economy’s final goods and services at a given price level. Effective demand is the aggregate spending level that validates firms’ production plans.
John Maynard Keynes: John Maynard Keynes was a British economist whose work reshaped macroeconomics during the twentieth century. He made effective demand central to his explanation of output and employment.
Potential output: Potential output is the level of production an economy can sustain when its resources are used at normal intensity. Effective demand can hold actual output below this productive ceiling.
Fiscal policy: Fiscal policy uses government spending and taxation to influence economic activity and public finances. Governments can raise demand directly when private spending is insufficient.
Aggregate supply: Aggregate supply is the total output firms are willing to produce at different price levels. Its intersection with aggregate demand identifies the output firms can sell.
The General Theory of Employment, Interest and Money: The General Theory is Keynes’s 1936 book explaining output, employment, and interest through aggregate economic relationships. It presents the principle of effective demand in its classic form.
Neoclassical synthesis: The neoclassical synthesis combines Keynesian short-run analysis with classical models of long-run market adjustment. It treats demand constraints as especially relevant in the short run, unlike Keynes’s broader claim.
Monetary policy: Monetary policy is central-bank action affecting interest rates, credit conditions, and the money supply. Lower borrowing costs may support investment and consumption when demand is weak.
Keynesian cross: The Keynesian cross is a diagram comparing planned expenditure with output to locate equilibrium national income. It shows how effective demand selects an equilibrium level of output.
Classical economics: Classical economics is a tradition emphasizing market coordination, flexible prices, and long-run allocation of resources. Keynes challenged the classical claim that market adjustment tends to secure full employment.

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