The Principle of Effective Demand

Abstract

We need, to start with, a few terms which will be defined precisely later. In a given state of technique, resources and costs, the employment of a given volume of labour by an entrepreneur involves him in two kinds of expense: first of all, the amounts which he pays out to the factors of production (exclusive of other entrepreneurs) for their current services, which we shall call the factor cost of the employment in question; and secondly, the amounts which he pays out to other entrepreneurs for what he has to purchase from them together with the sacrifice which he incurs by employing the equipment instead of leaving it idle, which we shall call the user cost of the employment in question. The excess of the value of the resulting output over the sum of its factor cost and its user cost is the profit or, as we shall call it, the income of the entrepreneur. The factor cost is, of course, the same thing, looked at from the point of view of the entrepreneur, as what the factors of production regard as their income. Thus the factor cost and the entrepreneur’s profit make up, between them, what we shall define as the total income resulting from the employment given by the entrepreneur. The entrepreneur’s profit thus defined is, as it should be, the quantity which he endeavours to maximise when he is deciding what amount of employment to offer. It is sometimes convenient, when we are looking at it from the entrepreneur’s standpoint, to call the aggregate income (i.e. factor cost plus profit) resulting from a given amount of employment the proceeds of that employment. On the other hand, the aggregate supply price of the output of a given amount of employment is the expectation of proceeds which will just make it worth the while of the entrepreneurs to give that employment.