Say's Law of Markets

What Is Say's Law of Markets?

Say's Law of Markets comes from chapter XV, "Of the Demand or Market for Products" of French economist Jean-Baptiste Say's 1803 book, Treatise on Political Economy. It is a classical economic theory that says that the income generated by past production and sale of goods is the source of spending that creates demand to purchase current production. Modern economists have developed varying views and alternative versions of Say's Law.

Understanding Say's Law of Markets

Say's Law of Markets was developed in 1803 by the French classical economist and journalist, Jean-Baptiste Say. Say was influential because his theories address how a society creates wealth and the nature of economic activity. To have the means to buy, a buyer must first have sold something, Say reasoned. So, the source of demand is prior to the production and sale of goods for money, not money itself. In other words, a person's ability to demand goods or services from others is predicated on the income produced by that person's own past acts of production.

Say's Law says that a buyer's ability to buy is based on the buyer's successful past production for the marketplace.

Say's Law ran counter to the mercantilist view that money is the source of wealth. Under Say's Law, money functions solely as a medium to exchange the value of previously produced goods for new goods as they are produced and brought to market, which by their sale then, in turn, produce money income that fuels demand to subsequently purchase other goods in an ongoing process of production and indirect exchange. To Say, money was simply a means to transfer real economic goods, not an end in itself.

According to Say's Law, a deficiency of demand for a good in the present can occur from a failure of the production of other goods (which would otherwise have sold for sufficient income to purchase the new good), rather than from a shortage of money. Say went on to state that such deficiencies of production of some goods would, under normal circumstances, be relieved before long by the inducement of profits to be made in producing the goods that are in short supply.

However, he pointed out that the scarcity of some goods and glut of others can persist when the breakdown in production is perpetuated by ongoing natural disaster or (more often) government interference. Say's Law, therefore, supports the view that governments should not interfere with the free market and should adopt laissez-faire economics.

Implications of Say's Law of Markets

Say drew four conclusions from his argument. 

1. The greater the number of producers and a variety of products in an economy, the more prosperous it will be. Conversely, those members of a society who consume and do not produce will be a drag on the economy.
2. The success of one producer or industry will benefit other producers and industries whose output they subsequently purchase, and businesses will be more successful when they locate near or trade with other successful businesses. This also means that government policy that encourages production, investment, and prosperity in neighboring countries will redound to the benefit of the domestic economy as well. 
3. The importation of goods, even at a trade deficit, is beneficial to the domestic economy.
4. The encouragement of consumption is not beneficial, but harmful, to the economy. The production and accumulation of goods over time constitutes prosperity; consuming without producing eats away the wealth and prosperity of an economy. Good economic policy should consist of encouraging industry and productive activity in general, while leaving the specific direction of which goods to produce and how up to investors, entrepreneurs, and workers in accord with market incentives. 

Say's Law thus contradicted the popular mercantilist view that money is the source of wealth, that the economic interests of industries and countries are in conflict with one another, and that imports are harmful to an economy.

Later Economists and Say's Law

Say's Law still lives on in modern neoclassical economic models, and it has also influenced supply-side economists. Supply-side economists especially believe that tax breaks for businesses and other policies intended to spur production, without distorting economic processes, are the best prescription for economic policy, in agreement with the implications of Say's Law.

Austrian economists also hold to Say's Law. Say's recognition of production and exchange as processes occurring over time, focus on different types of goods as opposed to aggregates, emphasis on the role of the entrepreneur to coordinate markets, and conclusion that persistent downturns in economic activity are usually the result of government intervention are all particularly consistent with Austrian theory. 

Say’s Law was later simply (and misleadingly) summarized by economist John Maynard Keynes in his 1936 book, General Theory of Employment, Interest and Money, in the famous phrase, "supply creates its own demand," though Say himself never used that phrase. Keynes rewrote Say's Law, then argued against his own new version to develop his macroeconomic theories. 

Keynes reinterpreted Say's Law as a statement about macroeconomic aggregate production and spending, in disregard of Say's clear and consistent emphasis on the production and exchange of various particular goods against one another. Keynes then concluded that the Great Depression appeared to overturn Say's Law. Keynes' revision of Say's Law led him to argue that an overall glut of production and deficiency of demand had occurred and that economies could experience crises that market forces could not correct.

Keynesian economics argues for economic policy prescriptions that are directly contrary to the implications of Say's Law. Keynesians recommend that governments should intervene to stimulate demand — through expansionary fiscal policy and money printing — because people hoard cash in hard times and during liquidity traps.