Demand-Side Economics

Demand-side economics states that economic growth is brought out by the demand for goods and services. The theory advocates increased government spending to create demand. It is also referred to as the Keynesian economic theory. The Keynesian demand-side economics places a heavy impetus on aggregate demand and the government’s intervention to induce the same.

The main purpose of the demand-side theory is to increase the money supply. Keynes claims that increased product demand stimulates increased economic activities and employment. Expansionary measures are taken by governments to deal with recessions. Governments initiate new projects to create jobs and lower income taxes. In addition, governments curtail interest rates on loans to increase consumers' liquidity.

• Demand-side economics or Keynesian theory considers the demand for goods and services as the main factor behind economic growth. The theory claims that goods supply alone is not adequate for enhancing an economy.
• The supply-side theory focuses on the rich and business owners. The demand theory, on the other hand, emphasizes the importance of increased money supply and demand.
• Increased purchasing power increases goods demand. This triggers production, and the economy requires more employment. Ultimately, an increase in demand results in economic growth.

Demand-side economics claims that economic growth is predominantly caused by demand for products. This economic theory was first put forth by John Meynard Keynes in the 1930s. Keynes proposed this model in response to the failure of classical economics during the great depression.

The Keynesian theory is the opposite of the classical theory of supply-side economics. Classical economics (supply-side) claims that goods supply is the most important growth factor. Keynes argues that a manufacturing plant may produce noticeable quantity, but unless there is a demand, there won't be any sales—the economy won't improve. Demand, in turn, depends on the consumer's purchasing power.

The theory also advocates the use of expansionary monetary policies—when government infuses money into circulation—the consumer's purchasing power rises. Central banks use monetary policies to control money circulation—by increasing or decreasing interest rates on loans.

Also, governments reduce taxes on income and commodities to increase consumers' purchasing power. The demand side theory advocates the use of such governmental measures. Increased purchasing power—increases goods demand—triggers production, and requires more employment. Ultimately, an increase in demand results in economic growth.

While the aggregate demand-side economics places a lot of importance in generating aggregate demand in an economy, there are different situations that demand different actions to induce the same. Let us understand the types of such policies through the discussion below.

There are two major demand-side policies in economics—monetary policy and fiscal policy.

#1 Monetary policy

This approach involves the regulation of credit or borrowing-related costs. Monetary policies are drafted by a country’s central bank—in the US, The Federal Reserve brings out monetary policies. It is an autonomous body that can make economic decisions without political interference.

For example, when a country undergoes economic slumps, the central bank uses expansionary policies (demand-side approach) to reduce interest rates on loans. When borrowing becomes easier for individuals and businesses, the circulation of money also increases. Increased money supply triggers a chain of events—ultimately, employment levels rise.  

#2 Fiscal policy

This approach involves a change in income tax rates and an increase in government spending. The government invests in new infrastructure projects to put more money into the hands of the consumers. In addition, the government curtails taxes on consumers—income tax.

Let us understand the concept of Keynesian demand-side economics with the help of a couple of examples from the practical world with leaders of major nations making revolutionary policies and some awful calls. These examples shall give us a practical overview of the concept and its prevalence and effect on our lives.

Example #1

The 2008 US recession one of the darkest times in the history of the global superpower. Economic policies had to reformed according to the current requirement of the economy to prevent it from tumbling even further.

President Obama employed demand-side policies to tackle downward trends. He applied a string of economic measures:

• Reducing interest rates on loans.
• Reducing the income tax burden on the American middle-class.
• Pushing for a $787 billion stimulus package into the economy.

This was the most comprehensive economic reform in American history since the 1930s great depression. The demand-side approach makes a visible dent irrespective of the size of an economy.

Example #2

The biggest part of any economy is consumption. Therefore, the idea of creating demand drove the economies across the globe. Right from 1930s till 2020 when the pandemic was declared, world leaders resorted to using Keynesian economics to drive their economics.

However, during the pandemic, the supply was hot leaving the demand to skyrocket overnight due to unavailability of essential goods and services for weeks, or months in some parts of the world. Therefore, an attempt to increase demand in late-2020 and 2021 was met with a high inflation rate. Thereby, policymakers shifted their focusses towards the supply aspect of things again.

The aggregate demand-side economics suggests that government intervention and policies aimed at boosting consumer spending and overall demand can lead to economic growth. However, there are aspects that are both beneficial and problematic for economies regarding this concept. Let us discuss the pros and cons through the points below.

Pros

1. Economic Stimulus: Demand-side policies can provide a quick boost to economic activity during periods of recession or economic downturns. By increasing government spending or cutting taxes, households and businesses have more disposable income.

2. Employment Creation: Increased consumer spending and business investment can lead to higher demand for goods and services, which, in turn, can lead to increased production and employment opportunities.

3. Social Welfare: Policies that increase government spending can be directed toward social programs, infrastructure development, and public services, which can improve the overall quality of life and well-being of citizens.

4. Market Failures: Demand-side policies can help address market failures, such as situations where prices don't accurately reflect supply and demand, by providing targeted interventions.

Cons

1. Inflation: One potential downside of demand-side policies is the risk of inflation. If demand increases too rapidly and outpaces supply, it can lead to rising prices. This can erode purchasing power and reduce the effectiveness of the policy.

2. Government Debt: Implementing demand-side policies often requires increased government spending. If not managed properly, this can lead to higher government debt levels, which may have long-term economic consequences.

3. Efficiency Concerns: Critics argue that government intervention in the economy can be less efficient than market mechanisms.

4. Long-Term Growth: Some critics argue that relying solely on demand-side policies might not address underlying structural issues that can impede long-term economic growth.

Both supply-side economics and demand theory chart the economic progress of a nation. Both theories discuss factors like curtailed taxes, new projects, infrastructure development, and government spending. Supply-side approach Vs. demand-side approach differences are as follows:

This has been a guide to Demand-Side Economics and its definition. We explain its types, and examples, and compared them with supply-side economics. You can learn more about it from the following articles -

• Demand and Supply Analysis
• Law of Supply and Demand
• Demand Curve