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Concept
Effective demand
Summary
In economics, effective demand (ED) in a market is the demand for a product or service which occurs when purchasers are constrained in a different market. It contrasts with notional demand, which is the demand that occurs when purchasers are not constrained in any other market. In the aggregated market for goods in general, demand, notional or effective, is referred to as aggregate demand. The concept of effective supply parallels the concept of effective demand. The concept of effective demand or supply becomes relevant when markets do not continuously maintain equilibrium prices.Robert Barro and Herschel Grossman, 1976. "Money, Employment, and Inflation, Cambridge Univ. Press.
One example involves spillovers from the labor market to the goods market. If there is labour market disequilibrium such that individuals cannot supply all the labor they want to supply, then the amount that they are able to supply will influence their demand for goods; the demand for goods, contingent on the constraint on the amount of labor that can be supplied, is their effective demand for goods. In contrast, if there were no labor market disequilibrium, individuals would simultaneously choose both their quantity of labor to supply and the quantity of goods to purchase, and the latter would be their notional demand for goods. In this example, the effective demand for goods would be less than the notional demand for goods.
Conversely, if there are goods market shortages, individuals may choose to supply less labor (and enjoy more leisure) than they would in the absence of goods market disequilibrium. The amount of labor they choose to supply, contingent on the constraint on the number of goods they can buy, is the effective supply of labor.
Another example involves spillovers from credit markets to the goods market. If there is credit rationing, some individuals are constrained in the number of funds they can borrow to finance goods purchases (including consumer durables and houses), so their effective demand for goods, as a function of this constraint, is less than their notional demand for goods (the amount they would buy if they could borrow all they want to).
Official source
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