Say's law of markets

2. 1/19/2015By Premraj Bhatta 2
1. Say’s Law of Markets
⎈ Say’s law of markets is the core of classical theory of
employment.
⎈ A famous French Economist Jeane Baptiste Say
enunciated the formal statement that “Supply
creates its own demand.”
⎈ It implies that the supply of goods generates
sufficient income to create demand for goods equal
to its supply.
⎈ Therefore, there is no possibility of overproduction
and unemployment in the economy.
⎈ Even if there is some unemployment in the short-
run, the economy automatically tends towards full
employment in the long-run.
1. Classical Theory of Employment

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Assumptions of Say’s Law of Markets
⎈ There is free market economy.
⎈ No government intervention.
⎈ Automatic adjustment of economic system due
to flexibility of wages, interest and prices.
⎈ Extent of market is limitless.
⎈ Closed economy, no trade links with any other
country,
⎈ Money is only a medium of exchange.
⎈ Validity of long-run,
⎈ Optimum allocation of resources,

4. Important facts of Say’s law
⎈ Production creates Demand for goods.
With the use of inputs in production process,
income is generated. This income is distributed to the
owner of inputs which they ultimately spend on
purchasing goods for their use. This causes demand for
produced goods. This is how supply creates its own
demand.
⎈ Barter and monetized economy,
Say’s law holds good in barter economy. It is
because, goods are produced for self consumption or to
get other goods in exchange for the produce. When
people offer their produce in barter for other goods,
they create demand for the goods.
This law is also valid in monetized economy, In
this economy money is used to buy or sale goods and
services.
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The inputs used in production generate money incomes
in the form of wages, interest, rent and profits. The
incomes are spent on purchasing the goods produced.
It creates demand. It implies that if there is production,
there is income and if there is income, there is demand
for goods whose production creates income. Thus,
supply creates its own demand in monetized economy.
⎈ No general overproduction
Say’s law states that there is no general
overproduction. When there is an increase in
production, there is also increase in income of related
factors. Consequently new demand is created and there
is no general over production. General overproduction
may exist in the short-run but it is automatically
adjusted by the market forces of demand and supply in
the long-run.

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⎈ Saving and investment equality
Generally income is spent on consumption. When
some amount of income remains unspent on consumption or
saved, overproduction may exists. But it is rate of interest
which plays important role to make a decision for both the
consumers and producers about saving and investment. How
much is to save and how much is to invest, depend on rate of
interest. The interaction for demand for and supply of saving
as a capital determines equilibrium rate of interest in market
at which the equality between saving and investment is
restored and there is no over production.
⎈ Labour Market
Labour always seek a higher wage rate but it causes a
fall in demand for labour and rise in unemployment. In a free
market economy flexible rate of wages automatically restores
full employment through the interaction of demand for and
supply of labour

7.  Implications of Say’s Law
The implications of the law are as follow
⍟ Full employment in the economy
According to Say’s law there is full employment in
the economy. It is because increase in production means
increase in employment and production continues until
the full employment is reached. In such a condition
production will be maximum.
⍟ Proper utilization of resources
This law is based on full employment in the
economy. According to which the proper utilization of
idle resources are ensured which will further help to
produce more and also generate more income.
⍟ No general overproduction
There is no general overproduction and no
unemployment. Increase in production generates
income for inputs and further demand is created for the
produce.
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⍟ Self adjustment mechanism
According Say’s law the self adjustment
mechanism brings up equilibrium in different markets.
So disequilibrium is a temporary situation. In a capital
market equality between saving and investment is
restored by the flexible interest rate while in labour
market equality between demand for and supply of
labour is maintained by the wage rate.
⍟ Wage cut creates full employment
This law assumes that wage-cut helps to restore
full employment by reducing production cost and price
level and increasing demand for goods. It denies the
wage rigidity policy in the economy.
⍟ Neutral role of money
This law is based on barter system where goods
are exchanged for goods. There is also assumed that
money is just a medium of exchange; it does not affect
the production process. So the role of money is neutral.

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 Criticism of Say’s Law of Markets
Say’s law was criticized by J. M. Keynes on the
following grounds.
 Supply does not create its demand
Say’s law states that supply creates its demand
but Keynes disagrees with this view. According to
Keynes in modern times, demand does not increase as
much as production increases. It is also not possible to
consumes the goods produced in domestic economy.
 Self-adjustment is not possible.
Say’s law assumes that shelf-adjustment
mechanism maintains full employment in the long-run.
But according to Keynes employment can be increased
by increasing in the rate of investment not by shelf-
adjustment mechanism in the long run. Neither he was
in favor of long-run nor he believed that we are all alive
in the long run.

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 Money is not neutral.
Say’s law assumes that the role of money is
neutral and it does not effect the economic activities.
Keynes gives due important to money. According to
him, money is held for income and business motives.
Individuals hold money for unforeseen contingencies.
Businessmen hold cash in reserve for future purpose.
So money is not neutral, it affect economic activities.
 Overproduction is possible.
Say’s law denies the possibility of overproduction
but Keynes is in against it. He believes that whole
factor-income is not spent. A portion of income is saved
but it is not automatically invested. Therefore, saving
and investment are always not in equality. Hence the
problems of overproduction and unemployment
remains in the economy.

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 Need of state intervention
Say’s law is based on free market policy but
Keynes has focused on the need of the intervention of
state at times of overproduction and mass
unemployment through fiscal and monetary policies.
 Wage-cut is not favorable
Supporting says law, Pigou favored a wage-cut
policy to solve the unemployment problem. But Keynes
is not in favor of wage-cut policy. He believes that wage-
cut brings deficiency in aggregate demand which
increases unemployment instead of removing it. So
wage-cut is not favorable.
 Saving and investment equality through income
Keynes opposes Say’s view that saving and
investment equality is restored through rate of interest.
He advocates, it is change in income rather than rate of
interest which bring about equality in them.

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 Unemployment Situation
According to Keynes full employment is a special
case because in capitalist economies, unemployment is
is fount existing. Capitalist economies are not found
functioning according to says law and supply always
higher than its demand. Therefore many workers are
willing to work at current wage rate but remain
unemployed.