Keynes’ Vision Of Effective Demand Is Unfulfilled

We hear that aggregate demand must be increased. Just today in a great article giving 3 mismatches that should be fixed in the global economy we read…

“First, aggregate demand is deficient relative to aggregate supply.” – (Restarting the global economy: Three mismatches that need concerted public action, Michael Spence, Danny Leipziger, James Manyika, Ravi Kanbur)

What they really want to say is that Effective Demand is deficient relative to aggregate supply. It is plain that economists still do not understand Keynes’ concept of effective demand. Keynes’ vision of effective demand still goes unfulfilled.

To explain effective demand, I refer to a book by Connell Fanning and David O Mahony, The General Theory of Profit Equilibrium: Keynes and the Entrepreneur Economy. Their book explores Keynes’ views on the profit equilibrium point of the effective demand limit.

Let’s read a bit from the book…

“In other words, the firm’s production and employment are determined by the maximum amount of profit it can hope to achieve and that amount is indicated by the highest point on the aggregate supply function at which it expects to be able to operate. This point is given by the highest level of proceeds it can expect to receive that is, the point of effective demand.”

“Thus the conditions of profit equilibrium may be said to hold when employment (in the individual firm) is such that effective demand and aggregate demand are equal.”

So right away we see a difference between aggregate demand (present demand) and effective demand (future demand limit).

When you look at the aggregate supply function, you see the aggregate demand function cross it at the current state of the economy. Then realize that there is a point on the aggregate supply function in the future where profits will be maximized. That distant point is the Effective Demand limit. When aggregate demand reaches this distant limit, aggregate demand will equal its effective limit and profits are maximized.