Say’s Law of Markets was rooted in the mainstream of supply-oriented classical Economics. Jean-Baptise Say, a French economist of the 19th century, asserted that “supply creates its own demand”.
Fig 1: Jean-Baptise Say (1767-1832)
Say’s Law of Markets is a theory from classical economics arguing that the ability to purchase something depends on the ability to produce and thereby generate income. Say reasoned that to have the means to buy, a buyer must first have produced something to sell. Thus, the source of demand is production, not money itself.
In Say’s words, “It is the production which creates markets for goods. Nothing is more favourable to the demand of one product than the supply of another.”
On the other hand, if there is general overproduction in the economy, then some labourers may be asked to leave their jobs. There may be a problem of unemployment in the economy for some time. In the long run, the economy will automatically tend toward full employment. In Say’s words, “It is a product which creates markets for goods. Nothing is more favourable to the demand of one product than the supply of another.”
Two Main Propositions of Say’s Law
(1) Production is the sole cause of demand:
Supply creates its own demand because production has a dual effect on the economy:
- It creates supply
- It generates factor income.
Income generated in the production process enables the people to demand the goods so created. Their demand is expressed through their consumption outlay. In this way, ‘consumption is co-extensive with production, ‘says J.S.Mill.
(2) There can be no Overproduction of goods at any time:
According to says law; as every additional supply creates an additional supply-demand, there can be no general overproduction. It stresses that aggregate supply always equals aggregate demand. In other words, while individual goods can be overproduced, the supply need not equal demand in a single market. But it will be absorbed by the economy as a whole. At the same time, while general overproduction was considered impossible according to Say’s Law, it also denied the possibility of a deficiency in aggregate demand. Similarly, it also denied the possibility of general unemployment. For, if resources are less than fully employed, there are incentives to expand production as entrepreneurs always strive for maximization of profits.
To express the process differently, any expansion in the output would create an equivalent expansion in income and in spending. In symbolic terms:
∆O = ∆Y= ∆E
Where, ∆O = Increase in output
∆Y = Increase in income
∆E = Increase in intended expenditure
Apparently, the additional income gives rise to an equal additional amount of intended expenditure. Hence the circular flow of income-expenditure is steadily maintained in the economy.
Fig 2: Say’s Law under a two-sector system
Assumptions of say’s Law
1. Optimum Allocation of Resources:
There is optimum allocation of resources as they are allocated to different channels of production in terms of proportionality and equality of marginal products.
2. Full Employment Equilibrium:
There is full employment equilibrium in the commodity and factor market. That is, all the resources of the economy are fully employed.
3. Perfect Competition:
There is perfect competition prevailing in the commodity market as well as the factor market. Thus, commodity prices are equal to average costs and factor prices are equal to marginal productivities.
4. Market Economy:
There is a free enterprise economy. The price and output decisions are taken by market forces.
5. Laissez-Faire Policy of the Government:
There is no government intervention in the economic field. The government follows a laissez-faire policy to facilitate automatic adjustment and smooth working of the market mechanism in the capitalist economic system.
6. Elastic Market:
The size of the market has no limits. Thus, there is an automatic expansion of the market with an increase in output offered for sale.
7. Market Automatism:
The free market economy and its working of price mechanism provide due scope to labour supply and the rising population also stimulates capital formation. In an expanding economy, new workers and firms will be automatically absorbed into the productivity channels by their own products in exchange without displacing or supplanting the existing firms and workers.
8. Circular Flow:
The circular flow of money is regular and continuous without any leakages. This implies that saving is nothing but another form of spending on capital goods. Savings are, thus, automatically invested. There is absence of hoarding. Hence, there is no break in the flow of income and expenditure. Income is automatically spent through consumption expenditure and investment expenditure.
9. Savings-Investment Equality:
Since all savings are automatically invested, savings always equal investment. Savings-investment equality is the basic condition of equilibrium in the economy. It is maintained by interest flexibility.
The economy’s equilibrium process is perceived from a long-term point of view.
Implications of Say’s Law of Market
1. Automatic attainment of full employment
In the long run, a free economy automatically attains equilibrium at the full employment level. Keynes held that Say’s Law is ‘equivalent to the proposition that there is no obstacle to full employment.’
2. Self-adjusting mechanism
There is an automatic adjustment when supply creates its own demand. An increase in supply will meet its own demand in the process of functioning as a free capitalist economy. Hence, there is no need for the government to intervene. On the contrary, any government interference in the economic field comes in direct conflict with the self-adjusting mechanism of Say’s Law of Markets.
3. There can be no deficiency of aggregate demand
Since supply automatically creates its own demand, there is no possibility of any general overproduction. Thus, Say’s Law is a denial of the possibility of deficiency in aggregate demand.
4. No problem of general unemployment
When there is no general overproduction, then there can be a problem of general unemployment in the long run, and the economy tends to remain at the full-employment equilibrium level.
5. Automatic resource adjustment and utilization in an expanding capitalist economy
In an expanding free enterprise economy, when new workers and new firms are productively absorbed, they do not supplant the output, income, and employment of the existing ones and as they release additional output and income, the community becomes automatically rich with the increasing size of national income. It also means that the employment of new or unused resources in the production process tends to pay its own way and confer benefits to society at large.
6. Money has only a passive role
Supply creates its own demand in real terms. Thus, money is just a veil. Behind the flow of money, there is a real flow of goods and services which is important. Thus, changes in the supply of money have no impact on the real economy’s process of equilibrium at the full employment level.
7. Built-in flexibility and automatic optimization
A capitalist economy under the laissez-faire policy has built-in flexibility. It functions automatically to optimum adjustments through freely operating market mechanisms and the price system.
8. Rate of interest is a strategic variable — an equilibrating force in the classical model
Savings-investments equality is brought about by the flexibility of interest rates. The rate of interest is, thus, a strategic variable in the equilibrium process of the economy. This point is the major classical postulate of the employment theory. In short, Say’s Law suggests that when savings would always be offset by an equivalent investment and as hoarding would always be zero, aggregate demand would always meet the aggregate supply, so there would be no general overproduction in the long run, and equilibrium will be maintained automatically at full employment level. By maintaining that, over-saving would be impossible. Say’s Law implied denial of the possibility of underemployment equilibrium.