Introduction:
Prof. Mahendra Kumer Ghadoliya
This has been named
after J.B. Say (1767-1832) a French classical economist. In 1803 his famous book
“A Treatise of Political Economy” was published. In this book he
presented the ‘Law of market’ which became famous as Say’s Law of Market or
simply Say’s Law. The law is the dictum ‘Supply creates its own Demand’ states
that aggregate production necessarily creates an equal quantity of aggregate
demand.
Say further argued that there can
never be a problem of general
overproduction or glut in the market. If
there is a surplus for one good there must be unmet demand for another. If
certain goods remain unsold it is because other goods are not produced.
According to this law the owners of factors of production receives income in
various forms e.g. rent, wages, interest and profit or loss in the production
process. The sum total of this output
produced by these factors of production generates sufficient income in the
society to purchase the produced output assuming that there are no leakages in
the income stream.
Assumptions of Say’s
Law:
The say’s law takes the following
assumptions of the classical school:
1.
All markets are
perfectly competitive so that agents decide how much to buy and sell on the
basis of a given set of prices which are perfectly flexible. The required
amount of labour and capital can be raised from the market on prevailing
prices.
2.
Firms are free to
enter or exist without affecting the equilibrium output and prices in the
market.
3.
The market is capable
of expansion. It expands with the increase in the volume offered for sale in
the market.
4.
All economic agents
(like firms and households) are rational and aim to maximise their profits or
utility; further more they do not suffer from money illusion.
5.
All savings are
automatically invested and this equality is brought about by the changes in the
rate of interest.
6.
Full employment is
considered to be normal situation and any lapses from full employment are
considered to be abnormal.
7.
Full employment is
guaranteed because of free play of market forces. The government does not
interfere in the automatic functioning of the economy. As any interference with
the free play of market forces shall
fail to bring about full employment.
Keynes’
Criticism of the Say’s Law of Market:
Keynes criticised the Say’s Law of Markets and the
classical theory of employment on the following grounds:
1.
Supply does not
create its own demand: According to the Say’s Law every supply creates its own
demand, e.g. if in an economy goods and services of Rs. 1000 crore are produced
it implies that this much of value has already been transferred to various
factors of production. This Law is based on the assumption that entire income
is spent and nothing is saved. Thus, whatever is produced is sold off in the
market. This assumption has failed on the criterion of time. In fact, it is a
proven fact on the criterion of time that people do not spend their entire
income on purchase of goods and services but also save. This savings in effect
is a leakage in the income stream. This reduces aggregate demand and some
production remains unsold and condition of over-production.
2.
Based on unrealistic assumptions: Say’s Law is based on unrealistic assumption
of perfect factor mobility, perfect competition and wage price
flexibility. Time has proved that these
assumptions does not hold good and therefore the Law is not applicable.
3.
Keynes’s critique:
Keynes criticised the Law and rejected the assumption of self-equilibrating and
automatic achievement of full employment
in the economic system. He said that unemployment is the common phenomenon in
almost all capitalist countries. The wage- price flexibility is absent and in
fact they are rigid.
4.
Economy is at equilibrium
at less than full employment level: In sharp contrast to the classical view
that full employment equilibrium is the normal situation, Keynes in his Famous book,
‘General Theory’ firmly held the view that in a free private enterprise economy
there are more chances for equilibrium to be established at less than
full-employment level. The simple argument advanced by Keynes was that in an
economy savings (S) and Investment (I) are done by two different groups. The motives
of Savers are different from the motives of investors.
In a free enterprise economy there is no mechanism
to ensure that what savers are planning to save is just equal to what investors
are planning to invest. If the planned investment expenditure is not equal to
planned savings then the present level of income and employment will not be
maintained and therefore there will be fluctuations in the level of income and
employment.
Keynes sais that there was no inherent reason to
believe that S+I would always be equal to output Y. Therefore there is no
assurance that demand would always be equal to supply. Savings are determined
primarily by income. But investment depends mainly in the short- run, on
marginal efficiency of capital (MEC)and the rate of interest (r), and in the
long run on factors like changes in technology and population growth. Thus,
investment demand, so determined will not necessarily fill the savings gap
between income and consumption. It will result in equilibrium at less than full
employment level quite in contrast with what the Say’s Law of market ensures.
5.
General cut in wages
cause a reduction in aggregate demand: Further Keynes strongly opposed Pigouvian
view that unemployment would disappear, if a general cut in wages was applied.
A general cut in wages according to Keynes will fail to bring about increase in
employment, because it will mainly cause reduction in aggregate demand (AD). It
is true that a general cut in money wages would reduce the cost in all
industries but this in it self would not increase employment because a cut in
wages would reduce the income of workers resulting in fall in aggregate demand.
This will deepen depression. Besides trade unions will resist such a general
wage cut. The fundamental fallacy in Say’s Law is that partial equilibrium
analysis which could apply to a particular industry has been extended to the
economy as a whole. Lowering a wage rare in a particular industry may increase
employment there without decreasing demand but if there is a general cut in
wages it will reduce income and so effective demand and volume of employment.
6.
Great Depression of
1930: Say’s Law of Market proved wrong during the great economic depression
during 1929-34 when there was over production in the market. Supply failed to
create its own demand. About 15 million workers were unemployed in early 1930s that
were prepared to accept any wage. Producers could not sell their production.
There was a general glut in the economy. Say’s law of market was not supported by facts
and the practical experience.
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