Saturday, August 22, 2009

Say’s Law of Market

According to J. B Say, an early nineteenth century French economists, “Supply creates its own demand”. In Say’s words “It is production which creates market for goods; for selling is at the same time buying and more of production, more of creating demand for other goods. Every producer finds a buyer”. In other words, every supply of output creates an equivalent demand for output, so that there can never be a problem of general over-production. Say’s law thus denies the possibility of the deficiency of aggregate demand.
Say’s law so conceived describes an important fact about the working of free exchange economy 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 of hither to unutilised labour and other resources pays its own way, because it 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 income to its employed factors, generates demand at the same time that it adds to supply. It is thus production which creates market for goods. It is the cause and sole cause of demand. David Ricardo, the chief among the classical economists said “No man produces but with a view to consume or sell, and he never sells but with an intention to purchase some other commodity which may be useful to him or while contributes to future production. In the words of James Mill “Consumption is co-extensive with production”.
Thus supply creates its own demand not only at the same time but also to an equal extent. Demand is generated simultaneously through the act of supply because supply creates income in the form of wages, interest and profit suppose 1,000 metres of cloth are 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 the purchasing cloth or some other commodity. The factors of production producing the other commodity will receive purchasing power as reward which may be spent on the purchase of cloth or again some other commodity. Thus the circle of production as well as of purchase goes on widening till the supply of no commodity remains unsold in the market. Hence the total or aggregate supply of commodities in the economy would be exactly equal to aggregate demand. There being no deficiency of demand, general over production is out of the question. It may be that at any given time, the supply of commodity may exceed the demand for it, but it will be only a temporary disequilibrium, ultimately demand will equal supply and the entire production will be taken off the market, provided of course, there is no interference in the working of the free market forces.
In brief Say’s law of market is denied of the possibility of general over production that is a denied of the possibility of a deficiency of aggregate demand. Therefore the employment of more resources will always be profitable and will take place to the point of full employment, subject to the limitations that the contributors of the resources are willing to accept rewards no greater than their physical productivity justifies. There can be no general unemployment, according to the view, if workers will accept what they are worth.
It is clear from the statement of the Say’s law given above that it is based on certain assumptions. The main assumptions are as follows.
(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 producer’s 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 market is limited by the volume of production, only then will demand equal supply or supply creates its own demand.
Following are the main implications of Say’s law
(i) One of the implication of Say’s law is that the economic system is self adjusting and functions automatically without being directed by any controlling authority. If there is any disequilibrium, it will be only temporary and there is a persistent tendency for the equilibrium to be restored. For instance, there is over production. Prices will fall, demand will increase and the extra supply will be cleared. Similarly if there is unemployment, wages would fall and it would become worth while to employ more labour so that unemployment disappears that is how there is automatic adjustment in the economic system. There is built in flexibility.
(ii) An important policy conclusion that follows from Say’s law is that the government should act on the policy of Laissez-afire (let alone) or of non-interference in economic activities. Any interference by the government in automatic working of the economic system will simply create imbalances and disequilibrium. In the absence of government interference, the disequilibrium will be temporary and will tend to be rectified by the free operation of market forces. Hence government should not raise barriers in the way of smooth working of the economy and economic forces. Owing to the built in flexibility in the economic system prices, wages and interest rates and the volume of production keep changing as the economic situation may require and there is no need for the government to interfere.
(iii) Another important conclusion that follows from Say’s law is that general over-production is not possible. That is so because will fall and increased demand under the impact of fall in prices will clear the surplus stock. At, times there may be over-production in a particular industry as distinguished from general over-production but this would also be temporary because automatically adjustments would come about. But in a free and fully competitive system general over production is simply out of the question. What ever the amount of annual products, it can never exceed the amount of annual demand.
(iv) Similarly, under free and perfectly competitive economic system, general unemployment is impossible, it follows from Pigovian for mutation of Say’s law that a general reduction in wages would create enough demand for labour to remove unemployment. Only there would be no wage regulation by government and no trade union pressure to resist reduction in wages. There will thus be persistent tendency to full employment. There may be sometimes unemployment in a particular, industry but no general unemployment is possible. Whatever the state of demand, there will always be, via wage adjustment tendency towards full employment.
The Say’s law has been by Keynes on the following grounds.
(i) Keynes refused to accept the classical theory that economic system was self-adjusting and that it worked automatically without any extraneous aid. Say’s law laid down that the supply and demand would always be in equilibrium with each other and further this process of equilibrium was automatic and self-adjusting Keynes refused to accept Say’s law, due to non-egalitarian structure of capitalist society, there are two principal classes the rich and the poor and wealth is unequally distributed between them. The result is that national consumption can not keep pace with national production because the propensity to consume of the richer classes is very low. This leads to deficient aggregate demand or in other words, to over production and general unemployment. In Keynes view State interference is necessary to bring about adjustment between supply and demand.
(ii) According to Keynes the general wage cut applied to all industries shall fail to bring about an expansion in the volume of employment, the reason being that a general cut in money wages would reduce the volume of purchasing power in the hands of workers. This will result in a reduction in aggregate effective demand which would have the effect of reducing the volume of employment in the community. Keynes was of the opinion that employment depend upon the level of effective demand which could be maintained by leaving wages intact. Keynes was thus bitter opponent of wage-cuts as a method of expanding employment opportunities.
(iii) 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 of wage rate in a particular industry, may increase employment there without decreasing demand. But if wages are reduced all around, it will reduce income and so effective demand and the volume of employment.
Difference between the Pigovian and Keynesian view on Say’s law is fundamental. While Pigou is of the view that employment depends upon the level of money wages and can be increased by lowering wages. Keynes contended that the volume of employment is determined by the level of aggregate effective demand which may be adversely affected by cuts in money wages. In Keynes view if wages rates were perfectly flexible unemployment could still exist if the aggregate demand was deficient. Hence it is wrong to assert as the classical economists did, that wage adjustment ensures full employment and interest rate adjustment tends to solve the saving investment problem.


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