Question
What is ‘effective demand’? How will you derive the autonomous expenditure multiplier when price of final goods and the rate of interest are given?
✓
Answer
Aggregate demand at the point of equilibrium is called an effective demand, because it becomes effective in determining national income. It is the level of demand which is fully met by corresponding supply with no tendency to expand or contract. Thus effective demand is the amount which is actually spent. In Keynesian framework which deals in short run analysis, equilibrium level of income and employment are determined solely by level of aggregate demand (i.e., effective demand) because aggregate supply (or national income) is assumed to be given and constant. Also because in the short run physical and technical conditions affecting aggregate supply do not often change. So it is the level of effective demand or AD which influences the level of output, income and employment. Thus for increasing the level of income, increase in effective demand is essential. In short, AD holds the key to the full employment level of income. The concept of effective demand can be explained with the help of the given diagram. 
The x-axis represents income/ output level and y-axis represents the level of aggregate demand. E is the equilibrium point where the two curves AS and AD meet. EG is the effective demand and output level is determined by AD (assuming the elasticity of supply to be perfectly elastic). Autonomous expenditure multiplier is derived as: Y = AD (at equilibrium) Y = A + cY [Where AD = A + cY] Y - cY = A Y (1 - c) = A$\text{Y}=\frac{\text{A}}{1-\text{c}}$
Where, A = Autonomous expenditure c = MPC Y = level of income$\frac{1}{1-\text{c}}=$ autonomous expenditure multiplier.
So, the autonomous expenditure multiplier is dependent on the income and MPC.
The x-axis represents income/ output level and y-axis represents the level of aggregate demand. E is the equilibrium point where the two curves AS and AD meet. EG is the effective demand and output level is determined by AD (assuming the elasticity of supply to be perfectly elastic). Autonomous expenditure multiplier is derived as: Y = AD (at equilibrium) Y = A + cY [Where AD = A + cY] Y - cY = A Y (1 - c) = A$\text{Y}=\frac{\text{A}}{1-\text{c}}$Where, A = Autonomous expenditure c = MPC Y = level of income$\frac{1}{1-\text{c}}=$ autonomous expenditure multiplier.
So, the autonomous expenditure multiplier is dependent on the income and MPC.
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Similar questions
Given the following data, find the missing values of ‘Private Final Consumption Expenditure’ and ‘Operating surplus’.
→|
S.No.
|
Particulars
|
Amount
(In $₹$ crores$)$ |
| $(i)$ |
National Income
|
$50,000$ |
| $(ii)$ |
Net Indirect Taxes
|
$1,000$ |
| $(iii)$ |
Private Final Consumption Expenditure
|
$?$ |
| $(iv)$ |
Gross Domestic Capital Formation
|
$17,000$ |
| $(v)$ |
Profits
|
$1,000$ |
| $(vi)$ |
Government Final Consumption Expenditure
|
$12,500$ |
| $(vii)$ |
Wages & Salaries
|
$20,000$ |
| $(viii)$ |
Consumption of Fixed Capital
|
$700$ |
| $(ix)$ |
Mixed Income of Self Employed
|
$13,000$ |
| $(x)$ |
Operating Surplus
|
$?$ |
| $(xi)$ |
Net Factor Income from Abroad
|
$500$ |
| $(xii)$ |
Net Exports
|
$2,000$ |
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