What exactly does Say’s Law mean in Layman’s terms? Is it basically saying that production determines consumption, and that supply creates its own demand?
As I understand it, it means that one can only demand as much as he owns. In other words, that aggregate demand is aggregate supply, in the sense that in order to acquire good X you need to already have good Y. It is a case against (general) overconsumption theories, since you can’t demand more than your existing supply.
Mr. Kates says the essence of Say’s Law is “Recessions are NEVER due to demand deficiency. An economy will NEVER produce more than its members will be able or willing to buy. High levels of savings do NOT cause recessions”.
edit: Also, Say’s analysis maintains that recessions are ALWAYS caused by errors in supply—when the structure of supply (not its level, its composition) fails to match with the structure of demand.
Kates says these propositions were held as true by all the classical economists, and Say’s Law was a response to Malthus (Keynes, says Kates, based his General Theory on Malthus’s underconsumptionist ideas). Only after 1936, says Kates, with the publication of Keynes’s General Theory, did mainstream economics abandon these classical tenets of Say’s Law.
the answer to the op’s question is really “it depends how you define say’s law”
if you are interested in the actual intellectual history of the concept (its interpretations and re-interpretations), i think baumol has a pretty good article here:
http://www.jstor.org/stable/2647144?seq=1
however if you are just interested in the way most modern austrians define of “say’s law”, then i think you will most enjoy this article by steven horowitz (here). a simple summary of “say’s law”, according to horowitz, is that “production is the source of demand”. or in other words, the value of goods you purchase depends on your income which depends on the value of goods you produce and sell.
an implication of this law is there cannot be excess supply across all markets. however this not exclude “keynesian gluts” (as mr. kates contends as described in the post above). as horowitz describes, we could very well have an excess supply for goods, but this implies that we also have an excess demand for money.
this is a concept i’ve tried to get across in several other posts using the following example:
An Example of Say’s Law In Action And How it Doesn’t Contradict Keynesian Economics
Let’s say we’re looking at an economy with three markets. A market for goods, a market for labor, and a market for money. Now, to be consistent with Say’s Law, we assume that there can never be excess supply across all markets. That is to say, if there is “excess supply”/"overproduction"in branch of the economy, there must be “excess demand”/“underproduction” in some other branch of the economy.
This assumption can be more clearly stated by saying that the following equality always hold.
(Y^d - Y^s) + (M^d - ((M^s)/p))+ (N^d - N^s) = 0
Where
Y^d = demand for “goods”
Y^s = supply of “goods”
M^d = demand for money
M^s = nominal money supply
M^s/p = the real supply of money (nominal money supply divided by the price of goods, p)
N^d = demand for labor
N^s = supply of labor
This equation says that the difference between demand and supply across all three markets must always sum to zero. In other words, if the demand for goods exceeds supply (Y^d > Y^s) it must be the case that supply must exceed demand in some other sector of the economy (for example the supply of labor exceeds demand, N^d < N^s).
Now, assuming that equality always holds, lets say unemployment started to rise in our make-believe economy and expenditures on final goods (GDP) started to fall. How would a Keynesian explain this “recession”?
Well, he might say that the demand for money has risen such that there is now excess demand in the money market (M^d > (M^s/p)). And as people are holding more of their income as money instead of spending, they are conversely using less of their income to purchase goods (Y^d < Y^s) and that this is leading to companies laying off workers (N^d < N^s). All of which is consistent and necessary for Say’s Law to hold:
(Y^d < Y^d) + (M^d > (M^s/p)) + (N^d < N^s) = 0
Keynes thought that supply creates its own demand. More accurately, supplying ALLOWS you to demand. New purchasing power is created by producing goods.