The Principle of Effective Demand,

The principle of effective demand occupies a key position in the Keynesian
theory of employment. Effective demand is the ability and willingness to spend by
individuals, firms and government. The level of output produced and hence the level
of employment depends on the level of total spending in the economy.
Keynes used ‘aggregate demand and aggregate supply approach’ to explain
his simple theory of income determination. The term ‘aggregate’ is used to describe
any quantity that is a grand total for the whole economy.

Aggregate demand is the total demand for all commodities (goods and
services) in the economy. Aggregate supply is the total of commodities supplied in
the economy. These two factors are called by Keynes as aggregate demand function
(ADF) and the aggregate supply function (ASF).
Keynes made it clear that the level of employment depends on aggregate
demand and aggregate supply. The equilibrium level of income or output depends on
the relationship between the aggregate demand curve and aggregate supply curve.
As Keynes was interested in the immediate problems of the short run, he ignored
the aggregate supply function and focused on aggregate demand. And he attributed
unemployment to deficiency in aggregate demand.
It is important to note that all demand is not effective. According to Keynes,
effective demand is that point where the ADF and ASF are equal. ASF represents
cost and ADF represents receipts. Cost must not exceed receipt. When the
entrepreneurs find that their receipts are less than their costs, they will stop offering
employment to new workers. So long as their receipts are higher than the costs, they
will increase employment as they can increase their profits by offering more and
more employment.
As already mentioned, the point of intersection between the two curves shows
the maximum possible employment. According to Keynes, the level of employment
depends on total demand and unemployment results as a consequence of a fall in
total demand. If unemployment is to be averted, the remedy lies in increasing the
effective demand.