NCERT Class 12 Economics — Chapter 6: Determination of Income and Employment

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Which one of the following best describes the "Effective Demand Principle"?

Official previous-year question

Verified 1 Aug 2026.

Options

AAggregate output is determined solely by the level of aggregate demand when supply is perfectly elastic.
BInvestment is the only determinant of national income in a two-sector model.
CSupply creates its own demand in the long run.
DThe price level adjusts instantly to clear the market of any excess demand.

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Solution

The correct option is Aggregate output is determined solely by the level of aggregate demand when supply is perfectly elastic..

Explanation

The Principle of Effective Demand is a fundamental concept in Keynesian macroeconomics. It posits that in an economy with underutilized resources, the equilibrium level of output and employment is determined by the total demand for goods and services (Aggregate Demand), rather than by the production capacity (Aggregate Supply).

Option Analysis

Supply creates its own demand in the long run. is incorrect: This statement defines Say’s Law of Markets ("Supply creates its own demand"), which is a Classical economic concept. Keynes refuted this law, arguing that supply does not automatically generate equivalent demand.
Aggregate output is determined solely by the level of aggregate demand when supply is perfectly elastic. is correct: The Effective Demand Principle operates on the assumption that in the short run, the Aggregate Supply curve is perfectly elastic (horizontal) due to the presence of excess capacity and unemployment. Under these conditions, producers are willing to supply any amount of goods at the prevailing price level. Consequently, the actual level of output is determined solely by the level of Aggregate Demand.
The price level adjusts instantly to clear the market of any excess demand. is incorrect: This describes the Classical assumption of price and wage flexibility, where markets clear instantly. Keynesian theory assumes that prices and wages are "sticky" or rigid in the short run, preventing instant market clearing.
Investment is the only determinant of national income in a two-sector model. is incorrect: In a two-sector economy, Aggregate Demand is the sum of Consumption (C) and Investment (I). While Investment is a crucial autonomous factor, it is not the only determinant; Consumption behavior is equally significant in determining national income.

Key Takeaway

Effective Demand is the specific level of Aggregate Demand that is met by Aggregate Supply. In the Keynesian framework, because supply is passive in the short run (due to slack in the economy), demand drives output.

Your note

More from Chapter 6: Determination of Income and Employment

With reference to the government sector in the determination of income, consider the following statements: 1. Government expenditure adds to the aggregate demand similar to investment and consumption. 2. Taxes imposed by the government increase the disposable income of households. 3. In the absence of indirect taxes, the GDP is identically equal to the National Income. Which of the statements given above is/are correct?

medium

Match List I with List II and select the correct answer using the code given below: List I | List II A. Excess Demand | 1. Amplifies changes in autonomous expenditure B. Deficient Demand | 2. Leads to a decline in prices in the long run C. Multiplier | 3. Signals that supply exceeds demand D. Inventory Accumulation | 4. Leads to a rise in prices in the long run

medium

Consider the following statements regarding Savings in an economy: 1. Savings is defined as the portion of income that is used for tax payments. 2. The Marginal Propensity to Save (MPS) is the change in savings per unit change in income. 3. If the Marginal Propensity to Consume (MPC) is 1, the Marginal Propensity to Save (MPS) will be 0. Which of the statements given above is/are correct?

easy

What does "Negative Inventory Investment" signify in an economy? 1. A rise in the stock of finished goods. 2. A depletion of existing stock to meet excess demand. 3. A situation where planned sales are less than actual sales. Which of the statements given above is/are correct?

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With reference to the consumption function in an economy, consider the following statements: 1. Autonomous consumption is the consumption expenditure that occurs only when income is positive. 2. Induced consumption is the portion of consumption that varies directly with the level of income. 3. The marginal propensity to consume determines the rate at which induced consumption changes as income changes. Which of the statements given above is/are correct?

easy

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The correct option is Aggregate output is determined solely by the level of aggregate demand when supply is perfectly elastic..

Explanation

Option Analysis

Supply creates its own demand in the long run. is incorrect: This statement defines Say’s Law of Markets ("Supply creates its own demand"), which is a Classical economic concept. Keynes refuted this law, arguing that supply does not automatically generate equivalent demand.
Aggregate output is determined solely by the level of aggregate demand when supply is perfectly elastic. is correct: The Effective Demand Principle operates on the assumption that in the short run, the Aggregate Supply curve is perfectly elastic (horizontal) due to the presence of excess capacity and unemployment. Under these conditions, producers are willing to supply any amount of goods at the prevailing price level. Consequently, the actual level of output is determined solely by the level of Aggregate Demand.
The price level adjusts instantly to clear the market of any excess demand. is incorrect: This describes the Classical assumption of price and wage flexibility, where markets clear instantly. Keynesian theory assumes that prices and wages are "sticky" or rigid in the short run, preventing instant market clearing.
Investment is the only determinant of national income in a two-sector model. is incorrect: In a two-sector economy, Aggregate Demand is the sum of Consumption (C) and Investment (I). While Investment is a crucial autonomous factor, it is not the only determinant; Consumption behavior is equally significant in determining national income.