Say's law

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In economics, Says Law or Says Law of Markets is a principle attributed to French businessman and
economist ean!"aptiste Say (#$%$!#&'() statin) that production or supply, inherently creates demand for what is
produced* +n important implication of Say's Law is that recessions do not occur because of inade,uate demand or
lack of money* +ccordin) to Say's Law, the production of )oods pro-ides the means to the producers to purchase
what is produced, and hence, demand will )row as supply )rows* For this reason, prosperity should be increased by
stimulatin) production, not consumption* +nother implication of Say's Law is that the creation of more money
simply results in inflation. more money demandin) the same ,uantity of )oods does not create an increase in real
demand*
Startin) with the work of ohn /aynard 0eynes, modern macroeconomists ar)ue that Say's Law only applies when
prices are fully fle1ible* In the short run, when prices are not fle1ible, a drop in a))re)ate demand can cause
a recession*
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Contents
2hide3
# Say's formulation
o #*# Recession and
unemployment
o #*( Role of money
( /odern interpretations
o (*# 0eynes -s* Say
o (*( /odern adherents
' See also
4 References
o 4*# 51ternal links
o 4*( Further readin)
2edit3Say's formulation
ames /ill restates Say's Law as 6production of commodities creates, and is the one and uni-ersal cause which
creates a market for the commodities produced6* In Say's lan)ua)e, 6products are paid for with products6 (#&7'8
p*#9') or 6a )lut can take place only when there are too many means of production applied to one kind of product
and not enou)h to another6 (#&7'8 p*#$&!:)* 51plainin) his point at len)th, he wrote that8
It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products
to the full e1tent of its own -alue* When the producer has put the finishin) hand to his product, he is most an1ious to sell it
immediately, lest its -alue should diminish in his hands* ;or is he less an1ious to dispose of the money he may )et for it.
for the -alue of money is also perishable* "ut the only way of )ettin) rid of money is in the purchase of some product or
other* <hus the mere circumstance of creation of one product immediately opens a -ent for other products* (J.B. Say,
1803: p.138-9)
2(3
=e also wrote8
It is not the abundance of money but the abundance of other products in )eneral that facilitates sales*** /oney performs no
more than the role of a conduit in this double e1chan)e* When the e1chan)es ha-e been completed, it will be found that
one has paid for products with products*
Say ar)ued a)ainst claims that business was sufferin) because people did not ha-e enou)h money and more money
should be printed* Say ar)ued that the power to purchase could be increased only by more production* ames /ill
used Say's Law a)ainst those who sou)ht to )i-e economy a boost -ia unproducti-e consumption* >onsumption
destroys wealth, in contrast to production which is the source of economic )rowth* <he demand for the product
determines the price of the product, but not if it will be consumed*
It is important to note that Say himself ne-er used many of the later short definitions of Say's Law and that Say's
Law actually de-eloped due to the work of many of his contemporaries and those who came after him* <he work of
ames /ill, ?a-id Ricardo, ohn Stuart /ill, and others e-ol-ed into what is sometimes called 6law of markets6
which was the framework ofmacroeconomics from mid #&77s until the #:'7s*
2edit3Recession and unemployment
+ccordin) to 0eynes (see more below), if Say's Law is correct, widespread in-oluntary unemployment (caused by
inade,uate demand) cannot occur* In-oluntary unemployment would only occur because of frictional chan)es in the
economy* Since the classical economists held Say's Law to be correct, they e1plained recessions as arisin) from
production not meetin) demand in quality* <hat is, supply had e1ceeded demand in some se)ments of the economy*
While in )eneral, more is not produced than there could be demand for, some particular products are produced too
much and conse,uently other products too little* <his 6disproportionality6 in relation to the consumer preferences
would lead to a producer not bein) able to sell the products in cost!co-erin) prices, causin) losses and the closin) of
se-eral firms* Since demand is ultimately determined by supply, the reduction in supply of these isolated sectors of
the economy will reduce the demand for products in the other sectors, causin) a )eneral reduction in output*
Such economic losses and unemployment were seen as an intrinsic property of the capitalistic system* ?i-ision of
labour leads to a situation where one always has to anticipate what others will be willin) to buy, and this will lead to
miscalculations* =owe-er this theory alone does not e1plain the e1istence of cyclical phenomena in the economy
because these miscalculations would happen with constant fre,uency* Some economists de-eloped a theory of
business cycles that tries to e1plain the business cycle as a cluster of errors of anticipation of demand caused by the
credit e1pansion*
<he kind of unemployment that results is what modern macroeconomics calls 6structural unemployment6* It differs
from 0eynesian 6cyclical unemployment6 that arises due to inade,uate a))re)ate demand*
2edit3Role of money
It is not easy to say what e1actly Say's Law says about the role of money apart from the claim that recession is not
caused by lack of money* @ne can read the second lon) ,uotation by Say (see abo-e) as statin) simply that money is
completely neutral, althou)h Say did not concern himself about the ,uestion* <he central notion that Say had
concernin) money can be seen in the first lon) ,uotation abo-e* If one has money, it is irrational to hoard it*
<o understand the role of this notion, restate Say's Law* <o Say, as with other >lassical economists, it is ,uite
possible for there to be a )lut (e1cess supply, market surplus) for one product, and it co!e1ists with a shorta)e
(e1cess demand) for others* "ut there is no 6)eneral )lut6 in Say's -iew, since the )luts and shorta)es cancel out for
the economy as a whole* "ut what if the e1cess demand is for money, because people are hoardin) itA <his creates
an e1cess supply for all products, a )eneral )lut* Say's answer is simple8 there is no reason to en)a)e in hoardin)* <o
,uote Say from abo-e8
;or is 2an indi-idual3 less an1ious to dispose of the money he may )et *** "ut the only way of )ettin) rid of money is in the
purchase of some product or other*
<he only reason to ha-e money, in Say's -iew, is to buy products* It would not be a mistake, in his -iew, to treat the
economy as if it were a "arter economy*
+n alternati-e -iew is that all money that is held is done so in financial institutions (markets), so that any increase in
the holdin) of money increases the supply of loanable funds* <hen, with full adBustment of interest rates, the
increased supply of loanable funds leads to an increase in borrowin) and spendin)* So any ne)ati-e effects on
demand that results from the holdin) of money is canceled out and Say's Law still applies*
In 0eynesian terms, followers of Say's Law would ar)ue that on the a))re)ate le-el, there is only a transactions
demand for money* <hat is, there is no precautionary, finance, orspeculati-e demand for money* /oney is held for
spendin) and increases in money supplies lead to increased spendin)*
>lassical economists did see that loss of confidence in business or collapse of credit will increase the demand for
money which would cut down the demand for )oods* <his -iew was e1pressed both by Robert <orrens and ohn
Stuart /ill* <his would lead to demand and supply to mo-e out of phase and lead to an economic downturn in the
same way as miscalculation in productions, as described by William =* "e-erid)e in #:7:*
=owe-er, in >lassical economics, there was no reason for such a collapse to persist* Cersistent depressions, such as
that of the #:'7s, are impossible in a free market accordin) tolaissez-faire principles* <he fle1ibility of markets
under laissez faire allow prices, wa)es, and interest rates to adBust to abolish all e1cess supplies and demands.
howe-er, since all economies are a mi1ture of re)ulation and free market elements, laisseD!faire principles (which
re,uire a free market en-ironment) would not be able to adBust effecti-ely to e1cess supply and demand*
2edit3/odern interpretations
+ modern way of e1pressin) Say's Law is that there can ne-er be a eneral lut.
2'3
Instead of there bein) an e1cess
supply ()lut or surplus) of )oods in )eneral, there may be an e1cess supply of one or more )oods but only when
balanced by an e1cess demand (shorta)e) of yet other )oods* <hus, there may be a )lut of labor (6cyclical6
unemployment), but that is balanced by an e1cess demand for produced )oods* /odern ad-ocates of Say's Law see
market forces as workin) ,uicklyE-ia price adBustmentEto abolish both )luts and shorta)es* <he e1ception would
be the case where the )o-ernment or other non!market forces pre-ent price chan)es*
+ccordin) to 0eynes, the implication of Say's 6law6 is that a free!market economy is always at what
the 0eynesian economists call full employment* <hus, Say's Law is part of the )eneral world!-iew of laisseD!
faire economics, i*e*, that free markets can sol-e the economy's problems automatically* (=ere the problems are
recessions, sta)nation, depression, and in-oluntary unemployment*) <here is no need for any inter-ention by the
)o-ernment or the central bankEsuch as the F*S* Federal Reser-eEto help the economy attain full employment*
+ll that the central bank needs to be concerned with is the pre-ention of inflation*
In fact, some proponents of Say's Law ar)ue that such inter-ention is always counterproducti-e*
>onsider 0eynesian!type policies aimed at stimulatin) the economy* Increased )o-ernment purchases of )oods (or
lowered ta1es) merely 6crowds out6 the pri-ate sector's production and purchase of )oods* <o contradict this, +rthur
>ecil Ci)ouEa self!proclaimed follower of Say's LawEwrote a letter in #:'( si)ned by fi-e other economists
(amon) them 0eynes) callin) for more public spendin) to alle-iate hi)h le-els of unemployment*
From a modern macroeconomic -iewpoint Say's Law is subBect to dispute* ohn /aynard 0eynes and many other
critics of Say's Law ha-e incorrectly paraphrased it as sayin) that 6supply creates its own demand6* Fnder this
definition, once a producer has created a supply of a product, consumers will ine-itably start to demand it* <his
interpretation allowed for 0eynes to introduce his alternati-e perspecti-e that 6demand creates its own supply6 (up
to, but not beyond, full employment)* Some call this 60eynes' law6*
2!itation nee"e"3
2edit3Keynes vs. Say
0eynesian economics places central importance on demand, belie-in) that on the macroeconomic le-el, the amount
supplied is primarily determined by effecti-e demand or a))re)ate demand* For e1ample, without sufficient demand
for the products of labor, the a-ailability of Bobs will be low. without enou)h Bobs, workin) people will recei-e
inade,uate income, implyin) insufficient demand for products* <hus, an a))re)ate demand failure in-ol-es
a #i!ious !ir!le8 if I supply more of my labor!time (in order to buy more )oods), I may be frustrated because no!one
is hirin) E because there is no increase in the demand for their products until after I )et a Bob and earn an income*
(@f course, most )et paid after workin), which occurs after some of the product is sold*) ;ote also that unlike the
Say's law story abo-e, there are interactions between different markets (and their )luts and shorta)es) that )o beyond
the simple price mechanism, to limit the ,uantity of Bobs supplied and the ,uantity of products demanded*
0eynesian economists also stress the role of money in ne)atin) Say's Law* (/ost would accept Say's Law as
applyin) in a non!monetary or barter economy*) Suppose someone decides to sell a product without immediately
buyin) another )ood* <his would in-ol-e hoardin), increases in one's holdin)s of money (say, in a sa-in)s account)*
+t the same time that it causes an increased demand for money, this would cause a fall in the demand for )oods and
ser-ices (an undesired increase in in-entories (unsold )oods) and thus a fall in production, if prices are ri)id)* <his
)eneral )lut would in turn cause a fall in the a-ailability of Bobs and the ability of workin) people to buy products*
<his recessionary process would be cancelled if at the same time there were dishoardin), in which someone uses
money in his hoard to buy more products than he or she sells* (<his would be a desired accumulation of in-entories*)
Some classical economists su))ested that hoardin) would always be balanced by dishoardin)* "ut 0eynes and
others ar)ued that hoardin) decisions are made by different people and for different reasons than decisions to
dishoard, so that hoardin) and dishoardin) are unlikely to be e,ual at all times* (/ore )enerally, this is seen in terms
of the e,uality of sa-in)(abstention from purchase of )oods) and in-estment in )oods*)
Some ha-e ar)ued that financial markets and especially interest rates could adBust to keep hoardin) and dishoardin)
e,ual, so that Say's Law could be maintained, or that prices could simply fall, to pre-ent a decrease in production*
(See the discussion of 6e1cess sa-in)6 under 60eynesian economics6*) "ut 0eynes ar)ued that in order to play this
role, interest rates would ha-e to fall rapidly and that there were limits on how ,uickly and how low they could fall
(as in the li,uidity trap)* <o 0eynes, in the short run, interest rates were determined more by the supply and demand
for money than by sa-in) and in-estment* "efore interest rates could adBust sufficiently, e1cessi-e hoardin) would
cause the -icious circle of fallin) a))re)ate production (recession)* <he recession itself would lower incomes so that
hoardin) (and sa-in)) and dishoardin) (and real in-estment) could attain balance below full employment*
Worse, a recession would hurt pri-ate real in-estment, by hurtin) profitability and business confidence, in what is
called the accelerator effect* <his means that the balance between hoardin) and dishoardin) would be e-en further
below the full employment le-el of production*
0eynesians belie-e that this kind of -icious circle can be broken by stimulatin) the a))re)ate demand for products
usin) -arious macroeconomic policies mentioned in the introduction abo-e* Increases in the demand for products
leads to increased supply (production) and an increased a-ailability of Bobs, and thus further increases in demand
and in production* <his cumulati-e causation is called the multiplier process