economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...

, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as

aggregate demand In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is ...

. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.

Robert Barro Robert Joseph Barro (born September 28, 1944) is an American macroeconomist and the Paul M. Warburg Professor of Economics at Harvard University. Barro is considered one of the founders of new classical macroeconomics, along with Robert Lucas, J ...

and Herschel Grossman, 1976. "Money, Employment, and Inflation'', Cambridge Univ. Press.

Examples of spillovers

One example involves spillovers from the labor market to the goods market. If there is labour market disequilibrium such that individuals cannot supply all the labor they want to supply, then the amount that they are able to supply will influence their demand for goods; the demand for goods, contingent on the constraint on the amount of labor that can be supplied, is their effective demand for goods. In contrast, if there were no labor market disequilibrium, individuals would simultaneously choose both their quantity of labor to supply and the quantity of goods to purchase, and the latter would be their notional demand for goods. In this example, the effective demand for goods would be less than the notional demand for goods. Conversely, if there are goods market

shortage In economics, a shortage or excess demand is a situation in which the demand for a product or service exceeds its supply in a market. It is the opposite of an excess supply ( surplus). Definitions In a perfect market (one that matches a s ...

s, individuals may choose to supply less labor (and enjoy more leisure) than they would in the absence of goods market disequilibrium. The amount of labor they choose to supply, contingent on the constraint on the number of goods they can buy, is the effective supply of labor. Another example involves spillovers from credit markets to the goods market. If there is credit rationing, some individuals are constrained in the number of funds they can borrow to finance goods purchases (including

consumer durables In economics, a durable good or a hard good or consumer durable is a good that does not quickly wear out or, more specifically, one that yields utility over time rather than being completely consumed in one use. Items like bricks could be consi ...

and houses), so their effective demand for goods, as a function of this constraint, is less than their notional demand for goods (the amount they would buy if they could borrow all they want to). Firms can also exhibit effective demands or supplies that differ from notional demands or supplies. They too can be credit constrained, resulting in their effective demand for goods such as

physical capital Physical capital represents in economics one of the three primary factors of production. Physical capital is the apparatus used to produce a good and services. Physical capital represents the tangible man-made goods that help and support the pro ...

differing from their notional demand. In addition, in a time of labor shortage, they are constrained in how much labor they can employ; therefore the number of goods they choose to supply at any potential goods price—their effective supply of goods—will be less than their notional supply. And if firms are constrained by excess supply in the goods market, limiting how much goods they can sell, then their effective demand for labor will be less than their notional demand for labor. The excess demands in different markets can influence each other. The presence of excess demand in one market influences effective demand or supply in another market, which may influence the degree of disequilibrium in the latter market; in turn, the constraints imposed on participants in that market influence their effective demand or supply in the former market.

History

Classical

economist An economist is a professional and practitioner in the social sciences, social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this ...

David Ricardo David Ricardo (18 April 1772 – 11 September 1823) was a British political economist. He was one of the most influential of the classical economists along with Thomas Malthus, Adam Smith and James Mill. Ricardo was also a politician, and a ...

embraced Say's Law, suggesting, in Keynes's formulation, that " supply creates its own demand". According to Say's Law, for every excess supply (glut) of goods in one market, there is a corresponding excess demand (shortage) in another. This theory suggests that a

general glut In macroeconomics, a general glut is an excess of supply in relation to demand, specifically, when there is more production in all fields of production in comparison with what resources are available to consume (purchase) said production. This exhi ...

can never be accompanied by inadequate demand for products on a

macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, an ...

level. In the challenge of Say's Law,

Thomas Malthus Thomas Robert Malthus (; 13/14 February 1766 – 29 December 1834) was an English cleric, scholar and influential economist in the fields of political economy and demography. In his 1798 book ''An Essay on the Principle of Population'', Mal ...

Jean Charles Leonard de Sismondi Jean may refer to: People * Jean (female given name) * Jean (male given name) * Jean (surname) Fictional characters * Jean Grey, a Marvel Comics character * Jean Valjean, fictional character in novel ''Les Misérables'' and its adaptations * Jea ...

and other 19th century economists argued that "effective demand" is the foundation of a stable economy.J.C.L. Simonde de Sismondi
Responding to the

Great Depression The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...

of the 20th century, in the 1930s Michał Kalecki and

John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...

concurred with the latter theory, suggesting that "demand creates its own supply" and developing a comprehensive theory of effective demand. According to

Keynesian economics Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output ...

, weak demand results in unplanned accumulation of inventories, leading to diminished production and

income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. Fo ...

, and increased

unemployment Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work during the refe ...

. This triggers a multiplier effect which draws the economy toward

underemployment equilibrium In Keynesian economics, underemployment equilibrium is a situation with a persistent shortfall relative to full employment and potential output so that unemployment is higher than at the NAIRU or the "natural" rate of unemployment. Theoretical f ...

. By the same token, strong demand results in unplanned reduction of inventories, which tends to increase production, employment, and incomes. If

entrepreneur Entrepreneurship is the creation or extraction of economic value. With this definition, entrepreneurship is viewed as change, generally entailing risk beyond what is normally encountered in starting a business, which may include other values t ...

s consider such trends sustainable,

investment Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...

s typically increase, thereby improving potential levels of production. In the 1960s, Robert Clower and

Axel Leijonhufvud Axel Leijonhufvud (6 September 1933 – 2 May 2022)
of the original. was a Swedi ...

did further work on effective demand, and in the 1970s

and Herschel Grossman published a well-known model of spillover effects upon effective demand.

Examples of spillovers

History

See also

References

Further reading