Say’s Law
Prof. Mahendra Kumar
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. This
characterizes the essential feature of exchange in an economy. Every product
that is offered in the market for sale creates an equivalent demand for output
to the full extent of its own value. 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.
Demand is created
through supply:
Say’s Law describes an important
fact that the main source of demand is the sum of incomes earned by the various
productive factors from the process
of production itself. The
employment to unemployed labour enlarges the market demand for goods by an
amount equivalent to the income created and the value of output produced. A new
productive process, by paying out incomes to its employed factors generates demand
at the same time that it adds to supply. It is thus production which creates
market for goods. The supply creates its own demand not at the same time but to
an equal extent. Demand is created simultaneously through the act of supply
because supply creates income in the form of wages, interest and profits. Suppose 1000 meters of cloth is produced. The
value of cloth has been distributed in the form of wages, rent, interest and
profit as reward to the participating factors of production. The purchasing
power so generated will be spent either on purchasing of cloth or some other
commodity. The factors of production producing other commodity will receive
purchasing power as reward which may be spent on purchase of cloth or again
some other commodity. Thus, the circle of production and purchase goes on
widening till the market clears. Thus, the total aggregate supply in the
economy will be equal to total aggregate demand. This can be illustrated with
the circular flow diagram. Money flows between firms and households in an
economy. Firms pay for hiring factors of production in the form of factor
income to the households for production and supply of goods. The income is
spent by the households on purchase of goods supplied by these firms. Thus,
completing the circular flow of money from firms to households and households
to firms in a two sector economy with the assumption that all income is spent
on consumption and nothing is saved. This assumption seems to be quite
unrealistic. However, it does not make any difference with the working of Say’s
law even if we assume some part of income is not spent but saved.
The real question then is what
happens to the unspent balance or savings. Suppose we have an economy with an
equilibrium income of Rs, 1000Cr. Households now decide to save 10% of their
income. The result will be fall in consumer expenditure. Profits will fall as
only Rs. 900 Cr. will be received back. But the savings of Rs 100 Cr. Will be
spent on investment i.e. purchase of new equipment and machinery. The savings
of the household will ultimately reach to firms via commercial banks this
completes the circular flow. Thus it follows from the Say’s Law that it always
pay to employ unemployed factors of production. The increase in supply
facilitates an expansion of market for the products. Thus, according to say’s
law, it would be unwise to let resource remain idle they can be profitable to
their employers.
Since supply creates its own
demand there is no limit to productive activity in the economy. In other words economic development can be
carried out to any extent for there can be no deficiency of aggregate demand.
Say’s Law was originally set forth
in the context of a barter economy where, goods are exchanged for goods and the
supplier of one good demands some other good. In general, classical economists
notably Ricardo, Mill gave support to the Say’s Law, which they believed also true
for a money economy. Money was nothing more than a convenient medium of
exchange, a veil covering the underlying real forces in the economy which
enabled market participants to avoid difficulties of barter economy. If Say’s
Law applies to a money economy then the logic holds true that whatever is
produced in an economy finds its market.
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.
***
No comments:
Post a Comment