Question

Define or Explain the following concept:
1) Autonomous Consumption
2) Aggregate Demand
3) Aggregate Supply
4) Effective Demand

Answer 1

1) Autonomous consumption: Autonomous consumption refers to the consumption that is independent of income. In other words, expenditure on such consumption is undertaken irrespective of the level of income. It includes consumption of such items as food, clothing, shelter, etc. Such an expenditure cannot fall to zero. This part of consumption expenditure is symbolically denoted by $\overline{C}$. The bar over C represents the constant consumption expenditure. In other words, it remains the same irrespective of the level of income.

2) Aggregate demand: Aggregate demand implies the total demand of final goods and services by various individuals in all the sectors in an economy. It expresses the total demand in terms of money. In this manner, it can be defined as the actual aggregate expenditure incurred by all the people in an economy on different goods and services.

AD = C + I + G + (X – M)
Where,
Demand by households - Private consumption expenditure (C)
Demand by firms - Private investment expenditure (I)
Demand by government - Government expenditure (G)
Demand by foreign sector- Net exports (X – M)
Where, X is exports and M is imports.

3) Aggregate supply: Aggregate supply refers to the aggregate production planned by all the producers during an accounting year. In other words, aggregate supply indicates the total amount of goods and services produced within an economy at a given general (or overall) price level during an accounting period. The aggregate supply function is represented as follows.
$AS=f\left(\overline{N},\overline{L},\overline{K},\overline{T}\right)$
where,
AS = Aggregate supply
N = Natural resources
L = Labour
K = Stock of capital
T = State of technology

4) Effective demand: Effective demand is defined as the total expenditure incurred by all people in an economy on the various goods and services produced in the economy over a given period of time. Effective demand is determined by the intersection of aggregate demand and aggregate supply. The concept of effective demand can be explained with the help of the given diagram.

The x-axis represents the income/output level and the y-axis represents the level of aggregate demand. E is the equilibrium point where the two curves (AS and AD) meet. EQ is the effective demand and the output level as determined by AD (assuming the elasticity of supply to be perfectly elastic).