The correct option is 1 only
Explanation
The "Effective Demand Principle" is a foundational concept in Keynesian macroeconomics. It posits that in the short run, the equilibrium level of output and employment in an economy is determined by the level of aggregate demand, rather than the productive capacity (aggregate supply) of the economy.
Statement-wise Analysis:
- Statement 1 is Correct: The principle operates under the assumption of the "short run," where the price level is assumed to be fixed (sticky prices). In this context, adjustments in the economy occur through changes in output quantity rather than changes in prices.
- Statement 2 is Incorrect: The principle assumes that aggregate supply is perfectly elastic (horizontal supply curve) up to the point of full employment. This implies that because there are unutilized resources (unemployment and excess capacity), firms are willing to supply whatever amount is demanded at the existing price level. A perfectly inelastic supply curve is characteristic of the Classical model or the long-run aggregate supply.
- Statement 3 is Incorrect: The principle implies that aggregate output is determined solely by the level of aggregate demand. The supply of labor determines the maximum potential output (full employment level), but the actual realized output is dictated by how much is demanded in the economy. The idea that supply (labor/production) determines output is associated with Say's Law in Classical economics.
Key Takeaway:
In the Keynesian short-run framework, prices are fixed, aggregate supply is perfectly elastic, and the level of economic activity (output and employment) is driven exclusively by Effective Demand.