Says Law.docx

In classical economics, Say's law, or the law of markets, states that "Supply creates its own demand", the aggregate production necessarily precedes an equal quantity of aggregate demand. Say's Law is often incorrectly said to state that production inherently creates consumption.[1] In his principal work, A Treatise on Political Economy (Traité d'économie politique, 1803), Jean-Baptiste Say wrote: "A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value."[2] And also, "As each of us can only purchase the productions of others with his own productions – as the value we can buy is equal to the value we can produce, the more men can produce, the more they will purchase."[3] Say further argued that this law of markets implies that a general glut (a widespread excess of supply over demand) cannot occur. If there is a surplus of one good, there must be unmet demand for another: "If certain goods remain unsold, it is because other goods are not produced."[3] Say's law has been one of the principal doctrines used to support the laissez-faire belief that a capitalist economy will naturally tend toward full employment and prosperity without government intervention.[4][5] Over the years, at least two objections to Say's law have been raised:  

General gluts do occur, particularly during recessions and depressions. Economic agents may collectively choose to increase the amount of money they hold, thereby reducing demand but not supply.

Say's law was generally accepted throughout the 19th century, though modified to incorporate the idea of a "boom-and-bust" cycle. During the worldwide Great Depression of the 1930s, the theories of Keynesian economics disputed Say's conclusions. Scholars disagree on the question of whether it was Say who first stated the principle,[6][7] but by convention, Say's law has been another name for the law of markets ever since John Maynard Keynes used the term in the 1930s.

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1History o 1.1Say's formulation o 1.2Early opinions o 1.3The Great Depression o 1.4Today 2Consequences o 2.1Recession and unemployment 3Assumptions and criticisms o 3.1Role of money 4As a theoretical point of departure 5Modern interpretations o 5.1Keynes versus Say 6See also 7References o 7.1Notes o 7.2Bibliography 8Further reading 9External links

History[edit] Say's formulation[edit] Say argued that economic agents offer goods and services for sale so that they can spend the money they expect to obtain. Therefore, the fact that a quantity of goods and services is offered for sale is evidence of an equal quantity of demand. This claim is often summarized as "supply creates its own demand", although that phrase does not appear in Say's writings. Explaining his point at length, he wrote: 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 extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products.[8] Say further argued that because production necessarily creates demand, a "general glut" of unsold goods of all kinds is impossible. If there is an excess supply of one good, there must be a shortage of another: "The superabundance of goods of one description arises from the deficiency of goods of another description."[9] To further clarify, he wrote: "Sales cannot be said to be dull because money is scarce, but because other products are so. ... To use a more hackneyed phrase, people have bought less, because they have made less profit." Say's law should therefore be formulated as: Supply of X creates demand for Y, subject to people being interested in buying X. The producer of X is able to buy Y, if his products are demanded. Say rejected the possibility that money obtained from the sale of goods could remain unspent, thereby reducing demand below supply. He viewed money only as a temporary medium of exchange. Money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another.[10]

Early opinions[edit] Early writers on political economy held a variety of opinions on what we now call Say's law. James Mill and David Ricardo both supported the law in full. Thomas Malthus and John Stuart Mill questioned the doctrine that general gluts cannot occur. James Mill and David Ricardo restated and developed Say's law. Mill wrote, "The production of commodities creates, and is the one and universal cause which creates, a market for the commodities produced."[11] Ricardo wrote, "Demand depends only on supply."[12] Thomas Malthus, on the other hand, rejected Say's law because he saw evidence of general gluts. We hear of glutted markets, falling prices, and cotton goods selling at Kamschatka lower than the costs of production. It may be said, perhaps, that the cotton trade happens to be glutted; and it is a tenet of the new doctrine on profits and demand, that if one trade be overstocked with capital, it is a certain sign that some other trade is understocked. But where, I would ask, is there any considerable trade that is confessedly under-stocked, and where high profits have been long pleading in vain for additional capital?[13]

John Stuart Mill also recognized general gluts. He argued that during a general glut, there is insufficient demand for all non-monetary commodities and excess demand for money. When there is a general anxiety to sell, and a general disinclination to buy, commodities of all kinds remain for a long time unsold, and those which find an immediate market, do so at a very low price... At periods such as we have described... persons in general... liked better to possess money than any other commodity. Money, consequently, was in request, and all other commodities were in comparative disrepute... As there may be a temporary excess of any one article considered separately, so may there of commodities generally, not in consequence of over-production, but of a want of commercial confidence.[14] Mill rescued the claim that there cannot be a simultaneous glut of all commodities by including money as one of the commodities. In order to render the argument for the impossibility of an excess of all commodities applicable... money must itself be considered as a commodity. It must, undoubtedly, be admitted that there cannot be an excess of all other commodities, and an excess of money at the same time.[15] Contemporary economist Brad DeLong believes that Mill's argument refutes the assertions that a general glut cannot occur, and that a market economy naturally tends towards an equilibrium in which general gluts do not occur.[16][17] What remains of Say's law, after Mill's modification, are a few less controversial assertions:   

In the long run, the ability to produce does not outstrip the desire to consume. In a barter economy, a general glut cannot occur. In a monetary economy, a general glut occurs not because sellers produce more commodities of every kind than buyers wish to purchase, but because buyers increase their desire to hold money.[18]

Say himself never used many of the later, short definitions of Say's law, and thus the law actually developed through the work of many of his contemporaries and successors. The work of James Mill, David Ricardo, John Stuart Mill, and others evolved Say's law into what is sometimes called law of markets, which was a key element of the framework of macroeconomics from the mid-19th century until the 1930s.

The Great Depression[edit] The Great Depression posed a challenge to Say's law. In the United States, unemployment rose to 25%.[19] The quarter of the labor force that was unemployed constituted a supply of labor for which the demand predicted by Say's law did not exist. John Maynard Keynes argued in 1936 that Say's law is simply not true, and that demand, rather than supply, is the key variable that determines the overall level of economic activity. According to Keynes, demand depends on the propensity of individuals to consume and on the propensity of businesses to invest, both of which vary throughout the business cycle. There is no reason to expect enough aggregate demand to produce full employment.[20]

Today[edit] Today, most mainstream economists reject Say's law.[citation needed] Steven Kates, although a proponent of Say's Law, writes: Before the Keynesian Revolution, [the] denial of the validity of Say's Law placed an economist amongst the crackpots, people with no idea whatsoever about how an economy works. That the vast majority of the economics profession today would have been classified as crackpots in the 1930s and before is just how it is.[21]

Keynesian economists, such as Paul Krugman, stress the role of money in negating Say's law: Money that is hoarded (held as cash or analogous financial instruments) is not spent on products. To increase monetary holdings, someone may sell products or labor without immediately spending the proceeds. This can be a general phenomenon: from time to time, in response to changing economic circumstances, households and businesses in aggregate seek to increase net savings and thus decrease net debt. To increase net savings requires earning more than is spent—contrary to Say's law, which postulates that supply (sales, earning income) equals demand (purchases, requiring spending). Keynesian economists argue that the failure of Say's law, through an increased demand for monetary holdings, can result in a general glut due to falling demand for goods and services. Many economists today maintain that supply does not create its own demand, but instead, especially during recessions, demand creates its own supply. Paul Krugman writes: Not only doesn't supply create its own demand; experience since 2008 suggests, if anything, that the reverse is largely true -- specifically, that inadequate demand destroys supply. Economies with persistently weak demand seem to suffer large declines in potential as well as actual output.[22] Olivier Blanchard and Larry Summers, observing persistently high and increasing unemployment rates in Europe in the 1970s and 1980s, argued that adverse demand shocks can lead to persistently high unemployment, therefore persistently reducing the supply of goods and services.[23] Antonio Fatás and Larry Summers argued that shortfalls in demand, resulting both from the global economic downturn of 2008 and 2009 and from subsequent attempts by governments to reduce government spending, have had large negative effects on both actual and potential world economic output.[24] A minority[citation needed] of economists still support Say's Law. Some proponents of the heterodox Austrian school of economics maintain that the economy tends to full-employment equilibrium, and that recessions and depressions are the result of government intervention in the economy.[25] Some proponents of real business cycle theory maintain that high unemployment is due to a reduced labor supply rather than reduced demand. In other words, people choose to work less when economic conditions are poor, so that involuntary unemployment does not actually exist.[26]

Consequences[edit] A number of laissez-faire consequences have been drawn from interpretations of Say's law. However, Say himself advocated public works to remedy unemployment and criticized Ricardo for neglecting the possibility of hoarding if there was a lack of investment opportunities.[27]

Recession and unemployment