Some basic principles of effective demand

Since I write about effective demand quite a bit here, I just want to post some of its basic principles.

What is Effective Demand?

Effective demand is a measure of the potential demand for the output of an economy. This potential establishes a limit upon output. In simple terms, the output of the economy will be constrained by the limit of effective demand, even below full-employment if such a situation was to arise.

Basic principles of effective demand

1. 100% utilization of available labor and capital would require paying out 100% of the total value-added income received to labor, namely the consumer.

2. Businesses in the aggregate could use 100% of the available labor and capital to maximize production. But if labor is paid less than 100% of total income received by businesses, 80% for example, there won’t be enough aggregate demand for businesses to sustain that level of production profitably. Therefore, there must be a lower limit for utilizing labor and capital that allow the rate paid to labor to create sufficient aggregate demand for profitable incentives.

3. The integrated utilization rates of the factors of production, labor and capital, are limited by the % of national income paid to labor, namely the consumer.

4. When businesses in the aggregate start utilizing more of their available resource factors, labor and capital, than what they pay out, profits will start to decrease.

5. If businesses pay out 3/4 of their income in the aggregate, they can only expect to use at most 3/4 of the aggregate productive capacity, as determined by multiplying together the utilization rates of labor and capital.

These principles are supported by the data so far.

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