Say's law

[tsmereka]

Well I recently read some literature by some “libertarian socialists” that mentioned that Say’s law was false, and that invalidated economics. At the time I of course thought they were just being absurd and did not pay much attention to it.

In intermediate macroeconomics today however, we talked about Say’s law and how it justifies much of Neoclassical macroeconomic theory. The professor laid it out as being “Supply creates its own demand.” He then contrasted the implications of that with Keynesian demand side theory.

Now from my perspective, “Supply creates his own demand” doesn’t seem necessarily true.

Consider the example of a Russian farmer when Napoleon’s troops are coming through. What do the soldiers supply? Pillage and rape. An economic bad. The Russian farmers have no demand for it, even though the supply is there.

However, it is certainly true that when producing an economic good, anyone can consume it. Let us say there is a simple economy where the only thing that they are capable of producing are fish. The people in this economy would certainly like to vary their diet to maximize their utility, and would pay a high price to eat things like dairy and vegetables if they could somehow get a hold of it. However, they can only get fish and they will likely consume all the fish they can.

These two situations represent different sides of the spectrum of Say’s statement. Am I interpreting Say’s law wrong? What does it really mean? Is it right or wrong and what are the implications of it and its relationship to Austrian econ?

[laminustacitus]

Say’s law was never really intended to be a doctrine-constructing statement, rather it was a refuation against mercantillist economics and it pointed out that there was only relative overproduction, but that, in the long-run, all produced goods will eventually be consumed. In fact, it is quite the tragedy that this law would become Say’s most lasting achievement. For more, here’s a good article: Lord Keynes and Say’s Law.

[nirgrahamUK]

it is not:

that supply creates its own demand (*1)

it is rather;

that supply constitutes a demand (*2)

1. imagines that by producing something, having a supply of something, necessarily somone will buy it, that it will be demanded. this is not necessarily true

2. states the simple truth that barring poltical force (i.e. expropriation/theft) the only thing that an economic actor can do to effect a real demand is to offer something; to sell/trade off a supply. hence supply/production is necessary for the would be demander in order for the would be demander to become an economic Real Demander. This is true.

[meambobbo]

Keynes argued that business downturns are caused by drops in “aggregate demand”.

Say’s law is used to refute this. It essentially says that supply and demand are simply invese sides of the same coin. For someone with money, he supplies money and demands goods. For someone with a product, he demands money and supplies goods.

Keynes measured demand via money exchanges. Thus, a decrease in money supply would appear as a decline in “aggregate demand”.

A real drop in aggregate demand is impossible without a similar drop in the output of real goods. What Keynes was actually referring to was a shift in demand preferences. Rather than demand money for goods, and then demand goods for that money; people demand money and save it. Keynes could not explain why this happened without resorting to circular logic.

Keynes didn’t accept the Austrian Theory of the Business Cycle, which explains why deflationary busts occur, which explains why price expectations shift from inflationary to deflationary, thus prompting people to demand cash more than they formerly demanded real goods. When falling prices and business failures are not distorted by government, things quickly stabilize, and demand to save cash disappears.

[tsmereka]

Hah, so is “Supply creates its own demand” a mistranslation or a deliberate misrepresentation?

Interestingly, I was reading Spooner just now and it looks like he not only understood Say’s law, but independantly came up with a lot of what is now called Austrian economic theory

THE writers on money seem never to have obtained the first glimpse of the fundamental law which governs prices, and which necessitates a constant and indefinite increase in the volume of money. That law may be illustrated in this manner:

Suppose an island cut off from all communication with the rest of the world, and inhabited by one hundred men. Suppose that these hundred men know no industry except the production of wheat; that they produce annually one thousand bushels, each man producing ten bushels, which is enough for his own consumption. Suppose further that these hundred men have money to the amount of five dollars each in gold. silver, and copper coins, and that these coins are valued by them as highly as similar coins are now by us. What will be the price of wheat among these men, compared with the coins? Plainly, it will bear no price at all. Each man producing for himself all he can eat, no one has any occasion to buy. Therefore none can be sold at any price.

But suppose that one after another of these hundred men leave wheat-growing, and engage in the production of other commodities, -each producing a different commodity from all the others,-until there shall be a hundred different commodities produced; only one man being left to produce wheat. And suppose that this one man has increased his product from ten bushels to one thousand. There is now just as much wheat as there was when all were employed in producing it. The only differences are, first, that the whole amount is produced now by one man, where before it was produced by a hundred men; and, secondly, that the ninety-nine men have each engaged in the production of some commodity, different from that produced by any oilier, but of which, we will suppose, all the others wish to purchase each his propor­tionate share for consumption.

There is now a hundred times as much wealth produced as when all produced wheat and nothing else. But each kind has only a single producer, while it finds a hundred consumers. And each man’s product, we will suppose, has the same value with every other man’s product.

What, now, will be the price of wheat among these hundred men relatively to the coins? Doubtless a dollar a bushel. When the first man abandoned wheat-growing, and betook himself to some other occupation, he created a demand for ten bushels of wheat, which he still wanted for consumption as before. This demand for ten bushels would doubtless be sufficient to give wheat the price of one cent per bushel, where it had no price before. When a second man of the hundred abandoned wheat-growing, he created a demand for ten bushels more; making twenty bushels in all. This increased demand would doubtless be sufficient to raise the market price of wheat to two cents a bushel. [*11]

When a third man of the hundred left wheat-growing for some other pursuit, his demand for ten bushels would raise the market price another cent; and so on, until by the time the ninety-nine had left wheat growing, the continually increasing demand would have raised the price to ninety-nine cents a bushel; for convenience of round numbers, say a dollar a bushel.

Here, then, wheat has been raised from no price at all to a dollar a bushel, not because there is any less wheat produced, or any more consumed, than before, but solely because the whole thousand bushels are now produced by one man, instead of being produced, ten bushels each, by the hundred different men who were to consume it; and because, further, each of the ninety-nine men, who have left wheat-growing, is able to purchase wheat, inasmuch as he has been producing some other commodity which brings him as good a price as the wheat brings to the man who still produces wheat.

Under this new state of things, then, the man who continues to produce wheat produces a thousand bushels, worth a dollar a bushel; that is, a thousand dollars’ worth in all. Each of the other ninety-nine produces an equal amount of’ market value in some other commodity. The whole hundred men, then, produce wealth that has now a market value of one hundred thousand dollars, where originally they had produced nothing that had any market value at all.

This change in the price of wheat has been produced, then, solely by reason of the diversity of industry and production that has taken place among these hundred men. And the market prices of all the other ninety-nine commodities have been affected by the same law, and to the same extent, as has been the price of wheat.

Here, then, is a hundred thousand dollars’ worth of commodities produced, each man producing a thousand dollars’ worth.

As each man retains a hundredth part of his product - that is, ten dollars’ worth-for his own consumption, he has nine hundred and ninety dollars’ worth for sale. The whole hundred men, therefore, have one hundred times nine hundred and ninety dollars’ worth for sale, which is equal to ninety-nine thousand dollars in all; for convenience of round numbers, say one hundred thousand dollars.

The hundred men, having each five dollars in coins, have in the aggregate five hundred dollars. To make the purchases and sales of these hundred thousand dollars’ worth of commodities, will require each of these five hundred dollars to be exchanged for commodities, on an average, two hundred times. That is, in carrying on the commerce of these hundred men for a year, their whole stock of money must be exchanged, on an average, once in a little less than two days. Or if we reckon but three hundred business days in a year, we shall find that the whole stock of money must be exchanged, on an average, once in every day and a half.

Such rapidity of exchange would be practicable enough, if the holders of the coins should all part with them readily at their true and natural value, instead of holding them back in the hope of getting for them more than they were really worth. But where there was so active a demand for the coins as to require that the whole stock be sold, on an average, once in every day and a half, it is natural to suppose that the holders of the coins would hold them back, in [*12] order to get more for them than their true and natural value. And in so far as they should do so, they would obstruct trade, and by obstructing trade obstruct and discourage production, and thus obstruct time natural increase of wealth.

[nazgulnarsil]

@meambobbo

Keynes could not explain why this happened without resorting to circular logic.

Keynes didn’t accept the Austrian Theory of the Business Cycle

I think that it is just that Keynes didn’t accept that money was a commodity like everything else. Keynes obviously felt that money shouldn’t be allowed to behave like other commodities.

[meambobbo]

@nazgulnarsil

I think that it is just that Keynes didn’t accept that money was a commodity like everything else. Keynes obviously felt that money shouldn’t be allowed to behave like other commodities.

I’m not sure this was the case. I think, rather, he did not think labor worked on the principles of supply and demand and market pricing. Thus, he would resort to nominal illusions, even though he knew that printing money would cause price inflation.

As far as the business cycle, he viewed the capital structure as a giant block equally effected in all areas by lower interest rates. Mises, rather, saw stages of production in the structure, with lower interest rates shifting investment from the final stages of production toward the earlier ones and lengthening the entire structure.

[Student]

laminustacitus

I think what you describe is also commonly referred to as Walras Law, which states that excess market supplies (or, likewise, excess market demands) must sum to zero. You are right this principle effectively states that there can be no such thing as a “general glut” or “general overproduction”, but apparently a lot of people posting after you are taking this to mean that demand driven recessions (ala Keynes) cannot take place or that Keynesian economics somehow violates Say’s Law/Walras Law.

Let me make it clear up front, Keynesian Economics does not violate Say’s Law. To see why, 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. We can represent such an economy with this simple equation.

(M^d - ((M^s)/p)) + (Y^d - Y^s) + (N^d - N^s) = 0

Here M is money, Y is goods, N is labor, and p is the price level. The superscripts “d” and “s” stand for demand and supply of the respective goods.

This equation says exactly what we said before. You cannot have an excess of supply across all markets. If you have an excess supply in one market, it must be met with an excess demand in another. This is what lamin has described as Say’s Law (though it is also the definition of Walras’ Law).

But does this “Law” imply that fluctuations in demand can never lead to fluctuations in output and that Keynesian Economics is “circular”? No. Suppose that, for some reason, there is an excess demand for money in the money market. Then Say’s Law tells us that we will have to have a corresponding excess supply in the goods market and/or the labor market.

(M^d positive) + (Y^d negative) + (N^d negative) = 0

Viola. We now have the ingredients for a demand driven recession. Whenever people want to hold onto more cash money (and yes this does happen, the cash reserves at major corporations, the money in your checking account, the pennies in your wallet, these are all forms of “hoarding” money), we could wind up with unemployment and oversupply in the goods market.

Thankfully, changes in the price level tend to eliminate this problem (looking back to the original equation we see that if the price level falls, the real money supply effectively increases, thus brining the money market back into equilibrium), but price adjustments do not occur over night. And the longer it takes for prices to change, the longer we might be in a demand driven recession. That isn’t to say that’s what’s happening now. Just saying it’s possible for demand driven recessions to occur.

[meambobbo]

Student, I would certainly agree that individuals can and do shift their demand for cash without requiring some preceding correlated event. I was not arguing that this implied circular logic. I was implying that a fundamental shift in aggregate demand without some event is simply highly improbable. On the other hand, the bust portion of the business cycle where interest rates rise provides a much more explanatory event. Credit becomes more expensive, businesses engaged in “malinvestment” go bankrupt, defaults rise, banks collapse, the money supply shrinks, prices fall, and people shift from inflationary to deflationary expectations.

Keynes, to my knowledge, never explained what caused a shift in aggregate demand.

[nirgrahamUK]

student, as far as your analysis goes, it still doesnt justify ‘keynesian’ style interference in the market, because any such interference would run counter to the valuations of the eocnomic agents that populate the economy in question (i.e. your imagined population that might spontaneusly want to hoard more cash and do with less consumer goods)

also, i would like an explanation of the first equation you present, what are the units in?, and are all the pluses and minuses the right way around? your market for goods bracket has a different form than your market for labour bracket…

[laminustacitus]

@Student

I think what you describe is also commonly referred to as Walras Law

Note that I never had any statements about the content of Say’s law, but rather I commented on its historical context and how it has been taken out of it.

[Student]

“student, as far as your analysis goes, it still doesnt justify ‘keynesian’ style interference in the market, because any such interference would run counter to the valuations of the eocnomic agents that populate the economy in question (i.e. your imagined population that might spontaneusly want to hoard more cash and do with less consumer goods)”

I wouldn’t say that.

1. Just people want to hold more cash doesn’t mean they want to consume less. It could be a simple shift in portfolio composition. Instead of holding stocks and bonds, people hold more cash. Think of it this way. If use all of my savings to buy some newly issued stocks, the company that issued those stocks will take my money and invest it (keeping it in the “circular flow” of the economy). If I instead put all of my savings into cash and just sit on it, I am essentially taking that purchasing power out of the circular flow.

2. There is still room for Keynesian intervention if our goal is to achieve equilibrium across all three markets and prices are slow to adjust (keep reading and don’t go off on a tangent about the concept of equilibrium). Optimally, prices would adjust to bring these markets back into equilibrium. Why? Well, let’s say that prices are set in the goods market. Since we have an excess supply of goods in the goods market, competition will force these prices down. How does this help excess demand in the money market? Because as the price level falls, thre real money supply (M^s/p) is essentially increased. If prices are slow to adjust in the goods market (like New Keynesians think they are), then we could conceptually increase the money supply to eliminate the recession (the excess supply in the goods market).

Now you should probably realize that this is a simple equation that leaves out a lot of things. It doesn’t address the question of whether reaching market equilibrium in all markets maximizes welfare (different topic). It doesn’t address the question of whether governments have the knowledge or incentive to adjust the money supply adequatley to prevent or end recessions (gee i wonder what your opinion on that question will be). But that is all kind of irrelevant to the central point I am discussing–there is NOTHING in Say’s Law that refutes the Keynesian argument that it is possible to have a demand driven recession.

If you want to refute Keynes you’re going to have to work a lot harder.

PS* You’re write, there is a typo in the labor market portion of the equation. That should be a minus instead of a plus.

[nirgrahamUK]

@Student

. If I instead put all of my savings into cash and just sit on it, I am essentially taking that purchasing power out of the circular flow.

yes, but why are you doing this, if its because you want to, then thats it, you have chosen to consume less, you have chosen to save/invest less. why should a government override your desires, (clearly expressed desires!)

keynesians dont believe that occasional shock can cause momentary dips in demand, that are recessions that should be dealt with. they believe that capitalism always and inevitably causes over production of consumer goods, and that there is a perpetual boom bust cycle. the boom is not artificial it is a natural feature of capitalism, they allege. they are wrong.

[meambobbo]

@Student

there is NOTHING in Say’s Law that refutes the Keynesian argument that it is possible to have a demand driven recession.

It seems it is about the time dimension as well. How does Say’s Law apply to credit?

It seems if credit is only issued against real savings, and money and credit are included in aggregate demand, the only way aggregate demand can decrease is if aggregate production decreases.

If you include credit not backed by real savings but on speculated future production (ie credit expansion), I’m unsure how Say’s Law applies. It would seem producing a contract to repay should not be valued as an increase in aggregate production. In real terms, production could remain constant, but if there were a spike in loans for some period, it would appear production spiked as well, producing the illusion of a recession, although it would not be in real terms.

[Student]

“yes, but why are you doing this, if its because you want to, then thats it, you have chosen to consume less, you have chosen to save/invest less. why should a government override your desires, (clearly expressed desires!)”

You need to re-read what I said. You missed where I said that holding more money DOES NOT necc mean consuming less goods. You also missed where I explain why government intervention is not overriding people’s desires. Please re-read the post and get back to me.

meams comment confuses me.
“It seems if credit is only issued against real savings, and money and credit are included in aggregate demand, the only way aggregate demand can decrease is if aggregate production decreases.”

money and credit are not included in aggregate demand. maybe an easier (if maybe less precise) way to think of it would be “aggregate spending”, because those are essentially its components. Typically, aggregate demand in a closed economy would be defined as
Y = Consumption Spending + Investment Spending + Government Spending

Hope this helps.

[Physiocrat]

@Student

Thankfully, changes in the price level tend to eliminate this problem (looking back to the original equation we see that if the price level falls, the real money supply effectively increases, thus brining the money market back into equilibrium), but price adjustments do not occur over night. And the longer it takes for prices to change, the longer we might be in a demand driven recession. That isn’t to say that’s what’s happening now. Just saying it’s possible for demand driven recessions to occur.

Yo Student, great to see you’re back. The main problem with your argument is that the “price level” takes time to fall. Taking a proper individualistic perspective price changes instantly. Supposing demand for money rises. For this to happen an individual must be determined to increase his cash balances. To do this he must either restrict his purchases or increase his sales. Either way some prices must fall. Resticting purchases of good x will lower the price immediately (as compared with what would have been- NB this is a counter factual statement). Increasing sales of y will reduce the price of y. All individuals care about about is specific prices of goods and money’s purchasing power in relation to them rather than a “price level” in general. In restricting his specific purchases he immediately gets what he wants: prices he deems to high are lowered, the purchasing power of money increases, the real value of cash balances rise and supply and demand are brought back into equilibrium immediately. No excesses of anything exist when the actor is not prohibited from doing the above. Thus demand driven recessions cannot exist.

[Fried_Egg]

This has all got me thinking…If a demand driven recession is an under supplied money market and an over supplied goods market, should we really call this a demand driven recession?

If we assume that prices are sticky and not adjusting downwards as they should (to clear the markets), do we not just have suppliers demanding too much for their wares? Why not call it a supplier driven recession?

What about imagining a strict barter economy? In this scenario, if the goods market is over supplied, does that constitute a general glut? According to Say’s law, our produce is our means to purchase the produce of others. But what if there is general tendancy to value one’s own produce too highly leaving many goods unpurchased?

This reminds me of past discussions I’ve had with people when they have declared their puzzlement that one good has outsold another even though it is inferior. What they often ignore is that the price of a good is actually part and parcel of the good itself (and how individuals evaluate them). If 100 green and 200 blue cars are demanded but 150 of each are actually supplied, we don’t call that a collapse of demand, we call it a malinvestment, a mismatch of production to demand. But if 300 cars are demanded at $1000 each but are produced at $1200 each, we call that a over-production or under-consumption. Why?

[nirgrahamUK]

it makes little sense to me, if money is desired, this is because of its use as a commodity of exchange, its use in facilitating the exchange of ones supply into ones demand for real goods. what then is an undersupply of money and oversupply of goods? people have too many yachts and not enough fiat notes to exchange to each other for goods that are so vastly plentiful they are almost worthless? add this to the list of problems worth having

[fakename]

a little confused on this so let me state my objections concisely.

obj1: say’s law states that because overproduction/underproduction produces incentives to produce or consume more then there will be a tendency for the market to always clear. Hence one person’s produce is someone else’s consumption good. But the equation (M^d - ((M^s)/p)) + (Y^d - Y^s) + (N^d - N^s) = 0 doesn’t accurately express this statement because all it expresses is a mathematical equality between the sum of all the values of an economy’s markets and zero. It posits no cause/effect relationship unlike say’s law which posits incentives as a motivating factor to limit supply or spur demand.

This leads to obj 2 where I say that the statement, "Keynesian Economics does not violate Say’s Law" is not sufficiently proved from the model because as it says (M^d positive) + (Y^d negative) + (N^d negative) = 0. This statement can only mean that the sum of two negative values of two markets of an economy, if they are = to a positive value for the remaining market of an economy, is equal to zero. But what we have in this model are a glut in money demand, a shortage in goods demand, and a shortage in labor demand while at the end claiming that all of the goods of an economy have been fully utilized -is this not the correct interpretation and if it is, is it not a wrong statement?