Say's law

Say's law is an economic principle, formulated by Jean-Baptiste Say, that asserts that there can be no demand without supply. In the economic sense, demand refers to a desire materially expressed in an exchange. Say's Law states that there can be no exchange unless the market participants have something to supply. Simply, this "law" represents a totally supply-driven view of the market.

The implication is that in order to raise market demand people must be willing and able to supply more: supply must be created before demand can come into being. To put it another way: effective demand (as opposed to mere hypothetical desire) is manifested and expressed in the form of supply. This can perhaps be seen most clearly in a barter economy where the means of demand is implicitly some form of supply: in a farmers' market, for example, the act of supplying potatoes is intimately tied up with the demand for pumpkins and other commodities. Some, however, regard Say's Law as also applying to monetary economies.

Contents

1 Modern Interpretations

2 Keynes vs. Say

3 Modern Adherents of Say's Law

4 See also

5 External links

6 Further reading

Modern Interpretations

A modern way of expressing Say's Law is that there can never be a general glut.[1] Instead of there being an excess supply (glut or surplus) of goods in general, there may be an excess supply of one or more goods, but only when balanced by an excess demand (shortage) of yet other goods. Thus, there may be a glut of labor ("cyclical" unemployment), but that is balanced by an excess demand for produced goods. Modern advocates of Say's Law see market forces as working quickly -- via price adjustment -- to abolish both gluts and shortages. The exception would be the case where the government or other non-market forces prevent price changes.

The implication of Say's "law" is that a free-market economy is always at what the Keynesian economists call full employment. Thus, Say's law is part of the general world-view of laissez-faire economics, i.e., that free markets can solve the economy's problems automatically (here the problems are recessions, stagnation, and involuntary unemployment). There is no need for any intervention by the government or the central bank (such as the U.S. Federal Reserve) to help the economy attain full employment. In fact, proponents of Say's law argue that such intervention is always counterproductive. Consider Keynesian-type policies aimed at stimulating the economy. Increased government purchases of goods (or lowered taxes) merely "crowds out" the private sector's production and purchase of goods: Say's Law means that the total level of output is constant, so that any increase in government purchases implies that there are fewer goods available for private consumption and investment. Increasing the money supply merely causes inflation, since the level of real output cannot be increased.

From a modern macroeconomic viewpoint Say's law is subject to dispute. John Maynard Keynes and many other critics of Say's law have paraphrased it as saying that "supply creates its own demand". Under this definition, once a producer has created a supply of a product, consumers will inevitably start to demand it. This interpretation allowed for Keynes to introduce his alternative perspective that "demand creates its own supply" (up to, but not beyond, full employment). Some call this "Keynes' law".

Keynes vs. Say

Keynesian economics places central importance on demand, believing that on the macroeconomic level, the amount supplied is primarily determined by effective demand or aggregate demand. For example, without sufficient demand for the products of labor, the availability of jobs will be low; without enough jobs, working people will receive inadequate income, implying insufficient demand for products. Thus, an aggregate demand failure involves a vicious circle: if I supply more of my labor-time (in order to buy more goods), I may be frustrated because no-one is hiring – because there is no increase in the demand for their products until after I get a job and earn an income. (Of course, most get paid after working, which occurs after some of the product is sold.) Note also that unlike the Say's law story above, there are interactions between different markets (and their gluts and shortages) that go beyond the simple price mechanism, to limit the quantity of jobs supplied and the quantity of products demanded.

Keynesian economists also stress the role of money in negating Say's Law. (Most would accept Say's Law as applying in a non-monetary or barter economy.) Suppose someone decides to sell a product without immediately buying another good. This would involve hoarding, increases in one's holdings of money (say, in a savings account). At the same time that it causes an increased demand for money, this would cause a fall in the demand for goods and services (an undesired increase in inventories (unsold goods) and thus a fall in production). This general glut would in turn cause a fall in the availability of jobs and the ability of working people to buy products. This recessionary process would be cancelled if at the same time there were dishoarding, in which someone uses money in his hoard to buy more products than he or she sells. (This would be a desired accumulation of inventories.)

Some classical economists suggested that hoarding would always be balanced by dishoarding. But Keynes and others argued that the hoarding decision are made by different people and for different reasons than the decisions to dishoard, so that hoarding and dishoarding are unlikely to be equal at all times. (More generally, this is seen in terms of the equality of saving (abstention from purchase of goods) and investment in goods.)

Some have argued that financial markets and especially interest rates could adjust to keep hoarding and dishoarding equal, so that Say's Law could be maintained. (See the discussion of "excess saving" under "Keynesian economics".) But Keynes argued that in order to play this role, interest rates would have to fall rapidly and that there were limits on how quickly and how low they could fall (as in the liquidity trap). To Keynes, in the short run, interest rates were determined more by the supply and demand for money than by saving and investment. Before interest rates could adjust sufficiently, excessive hoarding would cause the vicious circle of falling aggregate production (recession). The recession itself would lower incomes so that hoarding (and saving) and dishoarding (and real investment) could attain balance below full employment.

Worse, a recession would hurt private real investment, by hurting profitability and business confidence, in what is called the accelerator effect. This means that the balance between hoarding and dishoarding would be even further below the full employment level of production.

Keynesians believe that this kind of vicious circle can be broken by stimulating the aggregate demand for products using various macroeconomic policies mentioned in the introduction above. Increases in the demand for products leads to increased supply (production) and an increased availability of jobs, and thus further increases in demand and in production. This cumulative causation is called the multiplier process.

Most modern advocates of laissez-faire economics have rejected Say's Law, except perhaps in the long run. Instead, the emphasis is on the automatic adjustment of the labor market to get to full employment: if wages are allowed to fall, this increases the availability of jobs and allows full employment. Many advocates of laissez-faire economics (for example, economists at the International Monetary Fund) are quite activist in their approach, advocating the use of state power to destroy unions, minimum wage laws, and the like in order to make labor markets more "flexible" so that this idealized vision of labor markets can be attained.

Modern Adherents of Say's Law

See supply-side economics and Austrian school.