Says Law and Economic Growth

Critical Writing Assignment 3

Berenice Martnez Gutirrez

ABSTRACT
Sales and purchases are made constantly and continuously day in and day out. Many economists have studied the effects of such economic transactions and the lack thereof in the overall strength of the economy. Says Law, a theory that has been elaborated on, criticized, rejected and defended, illustrates the forms in which the tendencies to buy, sell, and save affect the overall economic stability. This essay will review the concepts related to Says Law, along with John Stuart Mills perception and elaboration on it. We will conclude with exemplifying Says law as we describe the effects that savings, investing, and borrowing have in our personal finances and the economy as a whole.

One of the most fundamental economical theories is Says Law. It addresses the issue of supply and demand, affirming that demand is simply a by-product of supply, or that supply creates its own demand (Library of Economics and Liberty, 2008). In simplicity, for every product that is sold, a product of the same value is bought; consequentially, the demand for products is equal to the supply available. This can be easily observed in a barter economy, where the sale of a good necessarily requires the simultaneous purchase of another. Sellers make their products with the sole purpose of being able to exchange them for anothers products. This exchange exemplifies the concept of Says law (Sowell, 2006). The introduction of money, however, makes the concept of Says law slightly more complex. In todays economy and for many centuries, people do not necessarily have to purchase goods immediately after being compensated for their sales. Instead, the option of saving the money for a purchase at a later date exists. With this time lag between sales and purchases, the opportunity for overproduction exists: if people are selling their products more often than they are buying other peoples products, then more products are being produced than being purchased. Critics of Says law argued that the economy would be stronger if the wealthy saved less and spent more, therefore maintaining the flow of the economy (Library of Economics and Liberty, 2008). Although Jean-Baptiste Say came up with the original thought of Says Law, he never said the words supply creates its own demand. Say simply stated, products are paid for with products (as in a barter economy). Moreover, a glut can take place only when there are too many means of production applied to one ECON 350 Martnez Gutirrez Assignment 3

Berenice Martnez Gutirrez 3 Says Law and Economic Growth

kind of product and not enough to another. Say affirms that overproduction is only possible when the selection of goods produced is not varied; we cannot all dedicate ourselves to producing shoes and expect everyone to be profitable. Says Law as originally developed by Say only applies to economies in which goods are obtained by the direct exchange of other goods, and the production of goods is sufficiently varied (Kates, 2007). In fact, Say did not observe Says Law as the concept into which it was later developed. It was John Stuart Mill who first said, Supply creates its own demand. Mill refuted the attacks from critics such as Malthus and Keynes as he argued that, though there may be a transitory overproduction of goods, in the long run demand and supply would always level out. In a period of growth and prosperity, the supply of money is high and people make purchases freely. The high demand and scarcity of resources (underproduction) leads to an increase in prices, which slowly turns the economy into a state of recession: higher prices call for less spending and more saving, so the supply of money decreases. During this period, more people become sellers and savers, and less become buyers: overproduction takes place. But with limited sales the price of goods lower again and the cycle starts over. John Stuart Mill supported Says Law, as he believed that demand and supply would indeed be equal but only in the long run (Kates, 2007). This is not to say that saving money is entirely bad for the economy. We have been told time and again that it is consumption that drives the economy forward, but we have also been advised to keep a comfortable amount of savings for a rainy day. So, which is better? Should we save, or should we spend? As with anything, a

ECON 350

Martnez Gutirrez

combination of both is desirable. Saving money does not necessarily stop the flow of consumption. The fact that we are not ready to spend the money we have now does not mean that no one does. When we deposit money into a bank or a financial institution, it does not sit idly waiting for us to come and withdraw it. The money is used to make loans to people who are keen to make purchases, but do not have the funds immediately available (Jackson, 2008). In other words, our thriftiness becomes anothers splurge. If it wasnt for our savings, the borrower would not be able to obtain the funds to advance the economy by realizing his projects, such as starting a business, buying a house or a car, taking a vacation, and so on. Additionally, we are helping the bank make a profit by collecting an interest expense from the borrower, and our own funds also grow as we receive interest payments from the bank. Essentially, as we save our money, we are advancing the economy by making a virtually risk-free investment in anothers endeavor, and profiting from the interest created. Savings, however, do not always mean investment. Savings can only result in investment and economic growth when the monies are deposited into a financial institution, in the form of a savings account, a certificate of deposit, a 401K and other accounts of the sort. Savings does not mean investment when the surplus funds are stashed away in a cookie jar or under our mattress where moneyseeking buyers cannot get ahold of them. In this case we are harming the economy as we take our capital out of the economic cycle and allowing it to lie idle. In this case, not only are we disrupting the natural flow of the economy, but also we are taking on a loss as our money loses value. ECON 350 Martnez Gutirrez Assignment 3

Berenice Martnez Gutirrez 5 Says Law and Economic Growth

When we consider the time value of money, we are reminded that one dollar in todays money is worth more than will be a dollar ten years from now. The price of commodities has a tendency to go up year after year, rather than down; so what I can buy with one dollar today might require a dollar and fifty cents in due time. When we save our money under the mattress, we are allowing it do devaluate continuously: neither does it strengthen the economy, nor does it makes any more affluent, but it does the total opposite. When we deposit our capital into the bank, the interest that it earns will make up for the value it has lost due to time, and sometimes it might even grow at a faster rate than its time devaluation. Keeping a savings account does not always harm the economy, but it must be done in such a way to allow for the growth of our money as it is invested in financing anothers venture as depicted in Says Law. John Stuart Mill was pioneer to many economic thoughts and theories, but his contribution to re-defining Says law is a landmark in classical economics. Says Law is not just historical content; it is a principle that was observed by many economists and still holds true today. Understanding Says law today plays a crucial role as a base to sound decision-making at the macroeconomic level.

ECON 350

Martnez Gutirrez

References:
Jackson, G. (2008, January 20). Without Savings There Can Be No Economic Growth. Retrieved December 5, 2012, from SafeHaven Preservation of Capital: http://www.safehaven.com/article/9274/without-savings-there-can-be-noeconomic-growth Kates, S. (2007). Mill, McCracken and the Modern Interpretation of Say's Law. History of Economics Review (46), 32-38. Library of Economics and Liberty. (2008). Jean Baptiste Say. Retrieved 2012, from The Concise Encyclopedia of Economics: http://www.econlib.org/library/Enc/bios/Say.html Scarlett - History of Economic Theory and Thought. (n.d.). John Stuart Mill's Monetary Theory. Retrieved from Economic Theories: http://www.economictheories.org/2008/07/john-stuart-mills-monetarytheory.html Sowell, T. (2006). On Classical Economics. New Haven: Yale University Press.

ECON 350

Martnez Gutirrez

Assignment 3