Say’s Law of Markets
Say's Law is commonly defined in its simplest and most common form as "supply creates its own demand"
What is Say's Law Of Markets?
Say's Law essentially states that "supply creates its own demand." In other words, the act of producing goods and services generates income, and this income, in turn, will be used to purchase the goods and services produced.
One of the issues with the world of ideas, especially in the social sciences, is that as new ideas clog the intellectual landscape, the understanding underlying previous concepts can be obscured.
The historian of ideas frequently has the unappreciated chore of correcting his colleagues when they believe anything a long-dead author said to be completely unrelated to what he was saying.
These misunderstandings frequently go beyond mere mistakes and can significantly impact our historical interpretations, social science ideas, and policy recommendations. Numerous instances of this phenomenon can be found in economics.
Here, the focus is on one of them: the fundamental misunderstanding of Say's Law of Markets, which bears the name of the famous Classical economist Jean-Baptiste Say, among economists and laypeople alike, as well as some of its ramifications.
Say's Law was previously referred to as the most fundamental "economic law" in all economic theory by W. H. Hutt.
Key Takeaways
- Say's Law is considered naive and most likely flat-out incorrect by economists since market economies have experienced numerous recessions and depressions over the past few centuries.
- Say explains the reasoning behind the idea that supply generates its own demand in the following passage: "It is a production which opens a demand for products. Thus, the mere circumstance of creating one product immediately opens a vent for other products."
- Say's Law suggests that we look at what is happening in money manufacturing to understand why the process of converting production into demand breaks down, making recessions and inflation fundamentally monetary events.
- We have argued that a more accurate understanding of Say's Law suggests that there is no inherent flaw in the market that leads to deficient aggregate demand and that the existence of real-world recessions is not a refutation of the Law.
Understanding the Say's Law Of Markets
Say's Law is commonly defined in its simplest and most common form as "supply creates its own demand," as if the mere act of placing a thing or service on the market was enough to spark demand for that particular good or service.
It is undoubtedly true that producers can spend money on things like advertising to encourage consumers to buy an item they have already decided to supply. However, this does not imply that a supply inevitably generates demand for the good in question.
Numerous business and product failures can witness this legal interpretation's evident absurdity. In this figurative sense, if Say's Law were true, we could all become extremely wealthy by creating whatever we please.
According to a more complex interpretation of Say's Law, an interpretation given by John Maynard Keynes seemed to blame the Classical economists; the total supply of goods and services and the total demand for those same goods and services will always be equal.
Furthermore, Say should have stated that this equality would occur when all resources have been fully utilized.
In light of this, it is said that classical economists held the notion that markets always attained the equilibrium of full employment. This holds true in one sense.
The real (ex-post) quantity of commodities purchased (demanded) and sold (provided) will never differ from one another. What one person sells, another will purchase.
However, Keynes likely believed the Classical economists meant something else, perhaps more along the lines that market economies will never have widespread surpluses or shortages since the revenue from sales will be enough to buy a number of commodities.
This is undoubtedly true in many ways, but this does not guarantee that there will be full employment because it is simple to give examples of high unemployment and unsold commodities. Indeed, Say's Law detractors have done just that.
They contend that Say's Law was, at best, naive and most likely flat-out incorrect by citing the multiple recessions and depressions that market economies have gone through.
Key Points from Say's Law
Perhaps we should look at what Say himself had to say about his purported law if we want to comprehend Say's Law more completely.
Say explains the reasoning behind the idea that supply generates its own demand in the following passage:
"It is a production which opens a demand for products. Thus, the mere circumstance of creating one product immediately opens a vent for other products."
Say argued that demand originates from the output, to put it another way. Money earned from one's production actions serves as the basis for one's power to demand products and services from others. Production rather than consumption is the source of wealth.
Hutt writes in his superb book on Say's Law:
"All power to demand is derived from production and supply. The process of supplying, or the creation and reasonable price of goods or services for replacement or expansion, maintains a steady or growing flow of needs.”
Hutt would be a little more specific in a later statement:
"The demand for any commodity is a function of the supply of non-competing commodities." It is crucial to include the qualifier noncompeting.
It is assumed that if I offer services as a computer technician for hire, the subsequent needs will be for products and services other than those of a computer technician (or a profession closely related to it).
This interpretation of Say's Law reveals the linkages between the various market sectors.
In particular, it supports the assertion that everyone is employed, which is equivalent to everyone being employed.
Note
As each employee secures a job, they can demand goods and services from all other non-competing suppliers, which opens up the possibility of their employment.
According to this interpretation, Say's Law does not refer to an equilibrium between total supply and total demand; rather, it depicts how general supplies become general wants. The amount of production constantly determines the ability to demand.
Production Must Come First In Say's Law
The differences between small, impoverished rural communities and affluent suburban areas demonstrate this phenomenon. Residents of the little town can only purchase a certain amount of goods and services since they produce a finite amount of value.
The variety of items, the quantity and variety of sellers, and the level of specialization among producers are, therefore, quite limited. In contrast, there is a remarkable variety of things in the more affluent suburbs, with many dealers offering highly specialized goods.
The fact that there is more rivalry in the wealthier location is perhaps the most significant factor since the market may support numerous vendors of a given commodity, given the level of producer wealth.
Say argues that this explains why a seller will probably generate more revenue as one of many rivals in a major city than as the lone vendor of goods in the sparsely populated countryside.
Note
The fact that production must come first is the key to comprehending Say's Law of Markets. Demand, also referred to as consumption, results from wealth creation.
Say's Law is essentially an extension of Adam Smith's observation that the size of the market restricts the division of labor. Smith argued that the demand for the specialized product would determine how much specialization would occur in a particular market.
Thus, ethnic restaurants outside the extremely popular Chinese and Italian restaurants are uncommon in tiny towns, as are radio stations that only play music in relatively specific genres, such as oldies from the 1970s.
This level of specialization can be supported in larger, wealthier communities because a larger population and a higher level of wealth production generate enough demand.
It is simplistic to state that output creates demand because all interactions between producers and consumers must occur via the instrument of money. To desire goods, one needs money, necessitating an earlier supply act.
We exchange labor or other resources for cash, which we use to make demands. The things we eventually want can be purchased with the help of money, which is an intermediary good.
The demand for current goods and services will, however, not exactly match the value of what has been produced, as some money remains in the producers' possession because we choose to keep some of our wealth that we temporarily store as money instead of spending it all.
Thus, it appears that Say's Law, even when properly understood, leaves open the possibility that aggregate demand is inadequate to buy what has been supplied, given the existence and use of money.
However, if the wealth is retained as bank-generated money, such as in a checking account (as opposed to Federal Reserve Notes), then people who borrow money from the bank that created it will receive the consuming power that was previously withheld.
The bank's ability to lend to others is based on the money I keep in their checking account. The production-generated wealth, which can be chosen not to spend, is given to the borrower in exchange for the ability to consume.
All Markets are Money Markets
The only way there can be excess supply or demand for things is if there is an opposite excess supply or demand for money.
This is because all market exchanges are of goods or services for money, making all markets money markets. Consider the more straightforward scenario of a product surplus, such as one might see in a recession.
If Say's Law is properly applied, it argues that an excessive demand for money is the cause of an excess supply of products. Buyers, who could be productive labor suppliers, cannot purchase goods because they do not have the necessary funds.
A general surplus of the things that goods trade against, which can only be money, on the other hand, can only result in an excess demand for the commodities.
Say's Law suggests that we look at what is happening in money manufacturing to understand why the process of converting production into demand breaks down, making recessions and inflation fundamentally monetary events.
We have argued that a more accurate understanding of Say's Law suggests that there is no inherent flaw in the market that leads to deficient aggregate demand and that the existence of real-world recessions is not a refutation of the Law.
This contrasts with Keynesian critics of Say's Law of Markets, who saw deficient aggregate demand resulting from various forms of market failure as the cause of economic downturns.
Instead, we can see that the root of the macroeconomic disorder is most likely monetary because too much or too little money will undermine the process by which our productive supply powers are translated into the ability to demand from other producers.
Note
Say's Law, when properly understood in its original sense and with the banking system, continues to provide a potent insight into how a market economy functions despite being disregarded in the onslaught of the Keynesian revolution.
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