Tuesday, July 23, 2013

On Effective Demand


According to Gavin Kennedy, Maynard Keynes used the term "effective demand" as Adam Smith used "effectual demand", to mean demand backed by ability to pay. In recent usage, Ed Lambert uses "effective demand" to mean potential demand. He seems to separate the phrase from the meaning "ability to pay". This is disturbing.

Lambert's work is interesting, but I wish he would call his work what he says it is: a study of potential demand. I'm reposting below mine of 17 December 2010, which bears some relevance.


Back in the day when Stefan Karlsson still allowed comments on his blog and I still found him interesting, he opened his post The Logic of Say's Law with a robust claim:

Say's law has come under discussion, so I will now explain what it means and what it doesn't mean and why it is true.

Parts of his post sounded wrong to me, so I commented:

Stefan, I have another question. You write: "Say's law in essence means that there can never be deficient aggregate demand.... The reason for that is we always have unfulfilled desires, and thus always want more.... That is essentially always true, and is if anything even more true during recessions when people are compelled to cut back...."

I am trying to understand your definition of aggregate demand. It seems to be the sum of effective demand or effectual demand as defined by Keynes and Adam Smith, plus some unfulfillable wish list of additional demand. I assume that as usual I am misunderstanding something you have said.

By the way effective demand (for Keynes) is the demand that calls forth supply; and similarly for Adam Smith....

According to Karlsson, "there can never be deficient aggregate demand" because "we always have unfulfilled desires, and thus always want more."

This is nonsense.

"Aggregate" means "added up" or "total." Aggregate demand is total demand. But economists -- apart from Karlsson, evidently -- do not include in aggregate demand everything that anyone could possibly think they might want. Economists mean by it the total of actual demand, accounted as actual purchasing. Not wishes and wants and daydreams.

By "aggregate" demand I mean the thing that Maynard called "effective demand" and Adam Smith called "effectual demand".

"Effective" demand to Keynes is the demand that has an effect. This is not unfulfillable demand of any sort, but actual purchases.

"Effectual" demand for Adam Smith is not unfulfillable demand, but the demand of those who are willing to pay:

"The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent, labour, and profit, which must be paid in order to bring it thither. Such people may be called the effectual demanders, and their demand the effectual demand; since it may be sufficient to effectuate the bringing of the commodity to market. It is different from the absolute demand. A very poor man may be said in some sense to have a demand for a coach and six; he might like to have it; but his demand is not an effectual demand, as the commodity can never be brought to market in order to satisfy it."

Karlsson confuses aggregate demand with absolute demand. To Karlsson, "aggregate" demand means the sum total of everything that people may wish for. His reply to my comment confirms this view:

"Arthurian": I may have expressed myself in a way which will appear confusing. What I meant was that deficient aggregate demand can't cause a recession, the reason for this is that demand is determined by what we want and since we can't have all that we want (especially during recessions/depressions!), the underlying cause is that we lack the ability to supply something that the potential producers of what we want also wants, and that the crisis therefore is based on the mismatch between the structure of demand and the structure of supply.

I said to Karlsson: I am trying to understand your definition of aggregate demand. He responded by bringing recession into his explanation, and underlying causes, and mismatched structures. But setting all that aside, it turns out that Karlsson provides the same definition he gave in the original post: "demand is determined by what we want and ... we can't have all that we want." Aggregate demand, for Karlsson, is absolute demand. It includes the poor man's coach and six, and also my Ferrari.

For Karlsson, demand is determined by wants, not by purchases. Since wants are limitless, in Karlsson's view demand is limitless. But this is not a definition of demand. It is part of a definition of economic scarcity.

Demand is measured by what we buy, not by what we would like to have.


Update 30 December 2010:

At the Billy Blog, Billy defines "effective demand" as "spending backed by cash."

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