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Say’s law of market. definitions. Supply creates its own demand -J.B.Say
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definitions • Supply creates its own demand -J.B.Say • Supply creates its own demand means that whenever a producer produces goods,he pays renumeration to the factors of production in the form of wages,interest,rent and profit.these payments constitute the income of the factors.
Assumptions of say’s law of market • Perfectly competitive economy • Flexible prices • Money-a veil • No hoarding • State in neutral • The large extent of the market • Unlimited opportunities for labour and capital • Long period • Production according to consumer’s preference
Explanation of law • Say’s law of market can be explained under two types of situations: • Say’s law and barter economy Whenever a producer brings goods to the market for sale,or creates supply,he does so in order to get other goods in exchange.in a barter system of exchange acts of sale and purchase of an individual go together. • Say’s law and monetary economy Classical economists apply say’s law to monetary economies.according to them,money serves only as a medium of exchange.when a producer sells his products he gets his income in terms of money.he will spend this money to buy other goods and services.the value of demand so created will be equal to the value of the goods supplied.
General Over-production is Impossible General Unemployment is Impossible Partial Over-production and Partial Unemployment are Possible Use of Unemployment Resources Pay for Itself Automatic Adjustment Equality between Saving and Investment Possibility of Unlimited Output and the Growth of Capital Implications of Say’s Law of Market
Say’s Law of market is the corner-stone of classical economics. Main implications of Say’s law are as follows: General Over-production is impossible: General over-production refers to that situation in which aggregate supply is more than aggregate demand over long period. According to Say’s Law, general over-production is impossible. He tells us that when production increases, the income of factors of production also increases which automatically leads to more demand. Thus, demand is always equal to supply. In this respect, J.S. Mill said.”Whatever the amount of the annual produce, it can never exceed the amount of the national demand. Implications of Says Law of Market
2)General Unemployment is impossible: General Unemployment refers to that situation in which supply of labour is more than its demand in general. When in the labour market supply exceeds its demand wage rate falls. Under perfect competition, labour is demanded up to the point where the wage rate is equal to marginal revenue productivity of labour (W=MRP). Fall in wage rate means reduction in cost to the employees and they will be tempted to employ more labour and produce more. As a result, employment will increase. The producers will go on increasing production till full employment situation is achieved. It may be possible that unemployment takes place for a short period, but such a situation will be short lived.
3)Partial Over-production and Partial Unemployment are possible: Say’s law maintains that a particular commodity may be over-produced. If the anticipations of the producers regarding the demand for a particular goods are not correct, then the supply of it may be more or less than demand. But demand and total supply tend to remain equal. It implies that if there is over-production of one good there may be under-production of the other. Situations of partial over-production and partial unemployment are possible temporarily for a short period. 4) Use of Unemployment Resources Pay for itself: Another implication of Say’s law is that if unemployed resources are put to use then they will pay for themselves, because when they are put to work they help in increasing the production. These resources will be paid their remuneration out of increased production.
5)Automatic Adjustment: According to Say’s law of market all economic parameters of a competitive economy are automatically adjusted. This adjustment takes place in three ways: Adjustment through Wage Rate: If supply of labour is more than demand, wage rate will fall. As a result, demand for labour will increase so as to be equal to supply. Adjustment through Price Level: Disequilibrium in demand and supply will cause automatic change in price level. If demand is less than supply, price will fall. As a consequence, demand will increase and supply decrease. Thus both will tend to be equal. Adjustment through Rate of Interest: Change in interest rate will help equalize saving and investment.
6)Equality between Saving and Investment: According to Say’s law, saving and investment are always equal. Say held the view that “to save is to spend”. Whatever is saved, is actually invested. If all there is temporary inequality between saving and investment then rate of interest will change in such a way as to make them equal. 7)Possibility of Unlimited Output and the Growth of Capital: Yet another implication of Say’s law is that there can be unlimited increase in output and capital. The reason being that aggregate demand and aggregate supply are always equal.
General Over-production is Possible General Unemployment is Possible Lack of Automatic Adjustment Say’s Law is not Logical Equilibrium between Saving and Investment Money is not merely a Medium of Exchange Long-term equilibrium Criticism of Say’s Law of Market:
Lord Keynes has criticised Say’s Law on the following grounds: General Over-production is possible: Aggregate demand is determined by consumption demand and investment demand. That part of income which is not consumed is saved. If this saving is fully invested, aggregate demand will be equal to aggregate supply. If planned savings is greater than planned investment, over-production becomes possible. 2)General Unemployment is Possible: Keynes criticizes classical argument that if there is general unemployment in an economy, wage rate will fall to once again increase the demand for labour to the level of full employment. Criticism of Say’s Law of Market
Lack of Automatic Adjustment: Keynes disagrees with Say’s law that economic parameters are automatically adjusted in the economy. There is automatic adjustment only when demand and supply adjust themselves, or what is saved is fully invested. It is not necessary that change in price level will invariably lead to change in demand and supply. Say’s Law is not Logical: The logic of Say’s law that aggregate demand will always be so much as to buy all the goods produced, is not correct. Proving this logic wrong, Keynes holds that aggregate demand can be divided into two parts: (i) Consumption demand- it depends on the income of an individual and psychological factors. (ii) Investment demand- it depends on rate of interest and marginal efficiency of capital.
Equilibrium between Saving and Investment: According to Keynes, it is not necessary that saving and investment decisions should always be identical. Keynes was of the opinion that equilibrium between saving and investment is not brought about by change in rate of interest but by change in the level of income. 6)Money is not Merely a Medium of Exchange: Say’s law is based on the assumption that money has no effect on economic activities. But according to Keynes and other economists, money is not merely a medium of exchange of goods but also a store of value. 7)Long-term equilibrium: Say’s law states that in the long run, it may be possible that aggregate demand may increase to become equal to aggregate supply. But Keynes asserted that it is the short-run and not the long-run equilibrium that is of great importance.
Most economists hold the view that in a developed capitalistic economy aggregate supply may become equal to aggregate demand in the long- run. However, this equality will not be due to Say’s law of Market or the flexibility of prices and wage rate. But the modern economists are of the opinion in the Long-run main cause responsible for that the equality between aggregate demand and aggregate supply is that the Central Bank of the country increase in supply money and expends credit to such an extent that aggregate demand becomes equal to aggregate supply. Validity of Say’s Law in Modern Times
There are two main reasons for it: The first reason for equality between aggregate supply and aggregate demand in the long-period is that, during this time period, because of technological development and new inventions, the opportunities of investment increase so much that all saving may be invested. The other reason is that, new technology has not become so much capital-intensive as not to increase the demand for labour, at all. In fact, with increase in real wages in the long-run, employment has a tendency to increase.
