1 say's law of markets

1/19/2015By Premraj Bhatta 2

1. Say’s Law of Markets

⎈ Say’s law of markets is the core of classical theory ofemployment.

⎈ A famous French Economist Jeane Baptiste Sayenunciated the formal statement that “Supplycreates its own demand.”

⎈ It implies that the supply of goods generatessufficient income to create demand for goods equalto its supply.

⎈ Therefore, there is no possibility of overproductionand unemployment in the economy.

⎈ Even if there is some unemployment in the short-run, the economy automatically tends towards fullemployment in the long-run.

1. Classical Theory of Employment


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,

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 theowner of inputs which they ultimately spend onpurchasing goods for their use. This causes demand forproduced goods. This is how supply creates its owndemand.⎈ Barter and monetized economy,

Say’s law holds good in barter economy. It isbecause, goods are produced for self consumption or toget other goods in exchange for the produce. Whenpeople offer their produce in barter for other goods,they create demand for the goods.

This law is also valid in monetized economy, Inthis economy money is used to buy or sale goods andservices.



The inputs used in production generate money incomesin the form of wages, interest, rent and profits. Theincomes 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 demandfor goods whose production creates income. Thus,supply creates its own demand in monetized economy.

⎈ No general overproductionSay’s law states that there is no general

overproduction. When there is an increase inproduction, there is also increase in income of relatedfactors. Consequently new demand is created and thereis no general over production. General overproductionmay exist in the short-run but it is automaticallyadjusted by the market forces of demand and supply inthe long-run.


⎈ Saving and investment equalityGenerally income is spent on consumption. When

some amount of income remains unspent on consumption orsaved, overproduction may exists. But it is rate of interestwhich plays important role to make a decision for both theconsumers and producers about saving and investment. Howmuch is to save and how much is to invest, depend on rate ofinterest. The interaction for demand for and supply of savingas a capital determines equilibrium rate of interest in marketat which the equality between saving and investment isrestored and there is no over production.⎈ Labour Market

Labour always seek a higher wage rate but it causes afall in demand for labour and rise in unemployment. In a freemarket economy flexible rate of wages automatically restoresfull employment through the interaction of demand for andsupply of labour

Implications of Say’s LawThe implications of the law are as follow

⍟ Full employment in the economyAccording to Say’s law there is full employment in

the economy. It is because increase in production meansincrease in employment and production continues untilthe full employment is reached. In such a conditionproduction will be maximum.⍟ Proper utilization of resources

This law is based on full employment in theeconomy. According to which the proper utilization ofidle resources are ensured which will further help toproduce more and also generate more income.⍟ No general overproduction

There is no general overproduction and nounemployment. Increase in production generatesincome for inputs and further demand is created for theproduce.



⍟ Self adjustment mechanismAccording Say’s law the self adjustment

mechanism brings up equilibrium in different markets.So disequilibrium is a temporary situation. In a capitalmarket equality between saving and investment isrestored by the flexible interest rate while in labourmarket equality between demand for and supply oflabour is maintained by the wage rate.⍟ Wage cut creates full employment

This law assumes that wage-cut helps to restorefull employment by reducing production cost and pricelevel and increasing demand for goods. It denies thewage rigidity policy in the economy.⍟ Neutral role of money

This law is based on barter system where goodsare exchanged for goods. There is also assumed thatmoney is just a medium of exchange; it does not affectthe production process. So the role of money is neutral.


Criticism of Say’s Law of MarketsSay’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 demandbut Keynes disagrees with this view. According toKeynes in modern times, demand does not increase asmuch as production increases. It is also not possible toconsumes the goods produced in domestic economy. Self-adjustment is not possible.

Say’s law assumes that shelf-adjustmentmechanism maintains full employment in the long-run.But according to Keynes employment can be increasedby increasing in the rate of investment not by shelf-adjustment mechanism in the long run. Neither he wasin favor of long-run nor he believed that we are all alivein the long run.


Money is not neutral.

Say’s law assumes that the role of money isneutral and it does not effect the economic activities.Keynes gives due important to money. According tohim, 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 overproductionbut Keynes is in against it. He believes that wholefactor-income is not spent. A portion of income is savedbut it is not automatically invested. Therefore, savingand investment are always not in equality. Hence theproblems of overproduction and unemploymentremains in the economy.


Need of state interventionSay’s law is based on free market policy but

Keynes has focused on the need of the intervention ofstate at times of overproduction and massunemployment through fiscal and monetary policies. Wage-cut is not favorable

Supporting says law, Pigou favored a wage-cutpolicy to solve the unemployment problem. But Keynesis not in favor of wage-cut policy. He believes that wage-cut brings deficiency in aggregate demand whichincreases unemployment instead of removing it. Sowage-cut is not favorable. Saving and investment equality through income

Keynes opposes Say’s view that saving andinvestment equality is restored through rate of interest.He advocates, it is change in income rather than rate ofinterest which bring about equality in them.


Unemployment SituationAccording to Keynes full employment is a special

case because in capitalist economies, unemployment isis fount existing. Capitalist economies are not foundfunctioning according to says law and supply alwayshigher than its demand. Therefore many workers arewilling to work at current wage rate but remainunemployed.