Download 2.0 Classical economist views on Say`s Law

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Table of Content
1.0 Introduction ................................................................................................................... 1
2.0 Classical economist views on Say’s Law ..................................................................... 2
4.0 Criticize the assumptions .............................................................................................. 5
5.0 Conclusion .................................................................................................................... 7
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1.0 Introduction
Jean Baptiste Say was born in Lyons. He lived in Geneva with his family after moving
from Nîmes for some time in consequence to the revocation of the Edict of Nantes. Say
was intended to follow a commercial career, and was sent, with his brother Horace, to
England: here he lived first in Croydon, in the house of a merchant, to whom he acted as
clerk, and afterwards in London, where he was in the service of another employed. He
published his principal work ‘Traité d'économie politique ou simple exposition de la
manière dont se forment, se distribuent et se composent les richesses’ In 1803, this is
French for Treatise on Political Economy or simply show how form, distributed and
consist wealth' (Kates, 1998).
Say’s principle states that there can be no demand without supply. A central element of
Say's Law is that recession does not occur because of failure in demand or lack of money.
One of the interpretations of this law is that Say's Law is supposed to be saying that the
aggregate supply of goods and services and the aggregate demand for goods and services
will always be equal, and equal at full employment. This version implies that if one
believes in Say's Law, then one cannot explain deviations from full employment. That is,
we must always be at full employment. In one sense this interpretation of the Law is
trivially true. If we compare the actual quantities of goods demanded and sold/supplied
they will always be equal (Keynes, 1936).
Later economists who explored the works of Say’s realized that he had his principles and
with these he argued out his points. Never deviating from the stand he had chosen.
Therefore it was only fit for them to accord his study the name Say’s Law.
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This paper explores the Say’s principle reviewing assumptions made about the principle
and thoughts of some classical economists.
2.0 Classical economist views on Say’s Law
Classical economics can be traced to the pioneering work of Adam Smith often referred
to as the father of economics. The specific event launching the modern study of
economics, as well as classical economics, was the publication by Adam Smith of An
Inquiry into the Nature and Causes of the Wealth of Nations in 1776. In this book, Smith
contended that the "wealth of a nation" was attributed to the production of goods and
services rather than stockpiles of gold in the royal vault, which was the prevailing view at
the time ().
According to Sowell, (1994) the work by Smith was refined and enhanced by scores of
others over the ensuing 150 years, including Jean-Baptiste Say, John Stuart Mill, David
Ricardo, Thomas Robert Malthus, and Alfred Marshall. Their work led to the creation of
a sophisticated body of principles and analyses that offered insight into a wide range of
economic phenomena both microeconomic and macroeconomic. Many of these principles
remain essential to the modern microeconomic theory.
Many classical economists believed that the law that Say came up with could be
explained differently for instance Keynes coined the phrase supply of a product creates
equal demand for the product in the market.
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Say's law is occasionally misinterpreted as applying to a single good, that is, the
production of a good is ensured to be purchased by waiting buyers. That law actually
applies to aggregate, economy-wide supply and demand. A more accurate phrase is
aggregate supply creates its own aggregate demand. This interpretation means that the act
of production adds to the overall pool of aggregate income, which is then used to buy a
corresponding value of production although most likely not the original production.
This law, first and foremost, directed attention to the production or supply-side of the
economy. That is, focus on production and the rest of the economy will fall in line. Say's
law further implied that extended periods of excess production and limited demand, the
sort of thing that might cause an economic downturn, were unlikely. Economic
downturns could occur, but not due to the lack of aggregate demand (Anderson, 2010).
3.0 Assumptions
According to Khushi, (2013) the following is a list of assumptions for the Say’s law to be
applicable in any economy:
(i) The law can operate only in a free exchange economy, where there is perfect freedom
for the buyers to buy and sellers to sell. There prevails perfect competition and there are
no restrictions imposed either on the producers or on the consumers and there is no price
control. (ii) There is free flow of money incomes. As these incomes are received they are
immediately spent. Even savings must be invested and spent on acquiring producerís
goods. (iii) Savings are equal to investment and this equally is brought about by flexible
interest rate. (iv) The Government follows the policy of laissez-faire and does not
interfere in any manner with the operation of the market forces. (v) The size of the
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market is limited by the volume of production, only then will demand equal supply or
supply creates its own demand. Supply of a product creates equal demand.
Other assumptions come from the classical economists themselves for instance there is
the assumption of flexible prices. This assumption states that prices are flexible. Price
flexibility means that markets are able to adjust quickly and efficiently to equilibrium.
While this assumption does not mean that every market in the economy is in equilibrium
at all times, any imbalance (shortage or surplus) is short lived. Moreover, the adjust to
equilibrium is accomplished automatically through the market forces of demand and
supply without the need for government action. The most important macroeconomic
dimension of this assumption applies to resource markets, especially labor markets. The
unemployment of labor, particularly involuntary unemployment, arises if a surplus exists
in labor markets. With a surplus, the quantity of labor supplied exceeds the quantity of
labor demanded at the exist price of labor (wages). With flexible prices, any surplus is
temporary. Wages fall to eliminate the surplus imbalance and restore equilibrium--and
achieve full employment (Sowell, 1994).
Another assumption developed from Say’s law is that the aggregate production of good
and services in the economy generates enough income to exactly purchase all output.
This notion commonly summarized by the phrase "supply creates its own demand”. Say's
law was a cornerstone of classical economics, and although it was subject to intense
criticism by Keynesian economists, it remains relevant in modern times and is reflected
in the circular flow model.
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Another assumption of classical economics is that savings by the household sector
exactly matches investment expenditures on capital goods by the business sector. A
potential problem with Say's law is that not all income generated by the production of
goods is necessarily spent by the household sector on consumption demand some income
is saved. In other words, while the production of $100 million of output generates $100
million of income, the household sector might choose to spend only $90 million,
directing the remaining $10 million to saving. If so, then supply does NOT create its own
demand. Supply falls $10 million short of creating enough demand (Sowell, 1994).
If this happens, then producers reduce production and lay off workers, which causes a
drop in income and induces a decline in consumption, which then triggers further
reductions in production, employment, income, and consumption in a downward spiral.
However, if this $10 million of saving is matched by an equal amount of investment, then
no drop off in aggregate demand occurs. Such a match between saving and investment is
assured in classical economics through flexible prices. However, in this case price
flexibility applies to interest rates. Should saving not match investment, then interest rates
adjust to restore balance. In particular, if saving exceeds investment, then interest rates
fall, which stimulates investment and curtails saving until the two are once again equal.
4.0 Criticize the assumptions
Due to the non-existence of a perfect competition mark then it is impossible for the first
assumption to apply because it suggests that the suppliers know everything about the
market and the market forces. And the customers understand everything about the
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product market. A perfect competition market is hypothetical and therefore to be put in
place as a support argument for a theory doesn’t make sense.
One of the greatest critiques of Say’s law was Maynard Keynes. Keynes promoted his
new theory of macroeconomics it part by showing where the existing classical economics
went wrong, especially why it was unable to explain the length and severity of the Great
Depression. A discussion of each of the three assumptions of classical economics
provides a bit of insight. Keynes was perhaps most critical of Say's law that supply
creates its own demand. Keynes questioned whether or not supply does in fact create
demand. While, in principle, revenue generated by production ultimately ends up as
household income, this does not happen instantaneously. In the meantime, households
can only spend the income that they actually have. If they have less income, then they
spend less, less is sold, less is produced, and less revenue is generated (Anderson, 2010).
The assumed equality between saving and investment was also criticized by Keynes. The
lack of flexible prices might also prevent equilibrium in financial markets. Should
interest rates not adjust, then saving might not match investment. Moreover, the
attainment of equilibrium might actually require negative interest rates. Keynes suggested
that interest rates were not the only or even most important factors affecting saving and
investment. Factors such as a dismal outlook on the economy might reduce investment
well below saving at any positive interest rate. As such, disequilibrium in which saving
exceeds investment means aggregate demand falls short of aggregate production and is
just the sort of thing that would create a sustained depression.
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In the flexible prices assumption, first up is the classical proposition that wages and
prices are flexible. Keynes argued that prices are really inflexible, especially in the
downward direct. This inflexibility or rigidity of prices results because sellers, both
output produces and resource owners are unwilling or unable to accept lower prices.
Inflexible prices thus prevent markets from eliminating shortages and surpluses. In
particular, rigid wages allow a surplus of labor (that is, involuntary unemployment) to
persist.
5.0 Conclusion
Say’s law tries to advance the concept that when a supplier supplies a good to the market
he/she is able to create equal demand for the product. This law has been disputed on
numerous occasions. Interesting that when Say came up with the principles he thought he
would be the greatest economist of his time. This he thought would be due to the fact that
his ideas were ground breaking and could be used to access the market forces of supply
and demand of most products in the economy. His principles of economics that he
proposed were later greatly criticized by many scholars because they believed that Say’s
Law could be conceptualized but not actualized in the economy. Therefore the reason
why it has drawn so much criticism from many of the classical economists who came
after him. But his theory is still held today to teach although most claim that anybody
who teaches economics using Say’s law is propagating a fallacy to the next generation.
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References
Anderson, L.W. (2010). Say’s Law: were the critiques right. Retrieved on June 3, 2013
from http://mises.org/journals/scholar/sayslaw.pdf
Horwitz, Steve. 2013. Understanding Say's Law of Markets. The Freeman. Foundation
for Economic Education.
Kaldor, N. (1983). “Keynesian Economics after Fifty Years.” Keynes and the Modern
World. ed.. Cambridge: Cambridge University Press,
Kates, Steven (1998). Say's Law and the Keynesian revolution: how macroeconomic
theory lost its way. Edward Elgard Publishing Limited.
Keynes, John Maynard (1936). The General Theory of Employment, Interest. New York:
Harcourt, Brace and Company.
Khushi, (2011). Assumptions of the Say’s law. Retrieved on June 1, 2013 from
http://wapspell.com/t76421p1-assumption_of_say_s_of_law.html
Sowell, Thomas. (1994). Classical Economics Reconsidered. Princeton, New Jersey:
Princeton University Press
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