Keynes' theory of insufficient effective demand

John Maynard Keynes (1883-1946) was a British economist who studied the phenomenon of an inadequate level of effective demand as the source of business cycle. This is known as his effective demand insufficient theory.

In the Great Depression of the early 1930s, unemployment is at its peak and economies around the world were suffering from drastic drops in output and prices. Keynes argued that the depression was caused by insufficient effective demand in the economy. He believed that the root cause of the depression was a lack of aggregate demand for goods and services, which in turn led to falling prices, output and wages.

The traditional view was that a market economy was self-correcting and that the government should not interfere. Keynes argued that in times of such a profound downturn, it was necessary for governments to intervene and stimulate the economy in order to boost aggregate demand. He proposed that governments should use their fiscal and monetary policies to increase aggregate demand and help push an economy out of this slump.

Keynes argued that in times of depressed economic conditions, the increase in the money supply was ineffective in boosting the economy. This is because people hold on to their money when they expect economic conditions to worsen, as they did during the Depression. He thus proposed that the government should directly inject money into the economy by raising spending on public works, and by lowering taxes, to increase aggregate demand.

Keynes believed that when aggregate demand increases, this will lead to higher levels of investment and consumption, which will lead to a revival of economic activity and employment. By increasing output and spending, this would boost economic activity and spur the growth of employment and wages, thus boosting the overall level of aggregate demand in the economy. As a result, he argued that there is a strong positive relationship between aggregate demand and output.

Keynes argued that his theory of effective demand was applicable even during periods of normal economic activity, as he had discovered that demand, investment and output were interconnected. He believed that there was a rational core to his theory, namely, that an imbalance between actual demand and potential output could lead to downturns in economic performance.

Although Keynesian economics has been largely discredited since the 1970s, due to the emergence of the efficient markets hypothesis and other neo-classical theories, his theory of effective demand inadequacy remains a fundamental idea that is still relevant today. Keynesian theory continues to this day to be advocated by a number of prominent economists, such as not Nobel Laureates Paul Krugman and Joseph Stiglitz, who argue that government intervention is necessary in times of economic downturns to prevent a further decline in output.

John Maynard Keynes Theory of Effective Demand is a well-known economics theory developed by British economist John Maynard Keynes in the 1930s. According to the theory, an economy will continue to grow as long there is effective demand for goods and services. Effective demand is essentially demand that is backed by the ability to pay for the good or service. When there is effective demand, resources are fully utilized and workers are employed.

Keynes believed that in modern economies, demand for goods and services had to be stimulated and maintained in order to ensure economic growth. He argued that when people had more money to spend, the economy would grow. Conversely, when people had less money to spend, demand would be reduced, resulting in sluggish economic growth or even an economic downturn.

Keynes argued that governments should implement appropriate economic policies to stimulate demand and maintain economic growth. He recommended public works programmes, such as road building, to increase aggregate demand and employment levels. He also advocated government spending during economic downturns and increased taxation when the economy was growing too rapidly.

Keynes Theory of Effective Demand became one of the most influential economic theories of the twentieth century. While the theory was developed in the 1930s, it remains influential and is often used by governments today to inform their economic policies. The theory has been used to explain long-term economic trends, such as recessions, and the effect of government policies on demand.