If the supply of final goods is assumed to be infinitely elastic at a constant price over a short period of time, aggregate output is determined solely by the value of aggregate demand. This is called.
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Effective demand principle
In the short run the economy usually has idle machines and workers, so firms can supply any quantity of final goods at the same price: supply is infinitely elastic, and the supply curve is a horizontal line. Supply then sets no limit on output, and what decides output is how much people want to buy:
If aggregate demand, the planned spending on consumption and investment, rises, firms produce more at the same price.
If aggregate demand falls, unsold stocks pile up and firms cut output.
Output settles where it equals aggregate demand. This idea, that aggregate output is determined solely by aggregate demand, is the effective demand principle. It is also why a rise in autonomous spending raises output by a larger amount through the multiplier.
Why the other options are incorrect
Option (1) Aggregate demand principle — Incorrect. There is no such principle.
Option (3) Law of demand — Incorrect. The law of demand says that a consumer’s demand for a good falls as its price rises. It is about one good and its price, not about what decides the aggregate output of the economy.
Option (4) Effective supply principle — Incorrect. There is no such principle.
NCERT (2025-26): “Summary … For simplicity we assume a constant final goods price and constant rate of interest over short run to determine the level of aggregate demand for final goods in the economy. We also assume that the aggregate supply is perfectly elastic at this price. Under such circumstances, aggregate output is determined solely by the level of aggregate demand. This is known as effective demand principle. An increase (decrease) in autonomous spending causes aggregate output of final goods to increase (decrease) by a larger amount through the multiplier process.” |