Say’s Law, Part 1: Exposition
J.B. Say was a 19th century French economist whose work was mostly ignored by mainstream economists other than for one minor aspect of his economic theory that came to be known as “Say’s Law.”
Say’s Law states that the demand for a good is made up of the production of other goods. This can be clearly demonstrated by an imaginary barter economy. Suppose there are only two goods, fish and potatoes. If an individual wants to buy a fish, he must exchange a potato for the fish. He could not buy the fish without first producing the potato. Thus, the production of the potato is what constitutes the demand for the fish. And vice versa. The production of the fish is what constitutes the demand for the potato. Now, if the individual who wanted the fish did not produce a potato to use in exchange first, there would be no economic demand. All he would have is desire. But desire is only one part of demand, the other being the ability to actually buy the product. And this ability only comes with production.
In a large economy, the production of a larger amount of goods will make up the demand for the fish. And in a money economy, money only being a medium of exchange, producers will exchange their products for money and then exchange money for the fish. The only difference is that there is an intermediate step.
Why has an economic law so simplistic attracted so much attention? Rothbard explains:
Say’s law is simple and almost truistic and self-evident, and it is hard to escape the conviction that it has stirred up a series of storms only because of its obvious political implications and consequences. Essentially Say’s law is a stern and proper response to the various economic ignoramuses as well as self-seekers who, in every economic recession or crisis, begin to complain loudly about the terrible problem of general ‘overproduction’ or, in the common language of Say’s day, a ‘general glut’ of goods on the market. ‘Overproduction’ means production in excess of consumption: that is, production is too great in general compared to consumption, and hence products cannot be sold in the market. If production is too large in relation to consumption, then obviously this is a problem of what is now called ‘market failure’, a failure which must be compensated by the intervention of government. Intervention would have to take one or both of the following forms: reduce production, or artificially stimulate consumption.
This underconsumptionist theory is what Keynesians believe causes the business cycle. But as Rothbard explained, the underconsumptionist belief far predated John Maynard Keynes.
If Say’s Law is true, there cannot be a general overproduction (the flip side of underconsumption) of goods on the free market. However, there can be overproduction in one area and underproduction in another, a misallocation of goods. This insight will help us understand what really causes business cycles, which will be explained in a future post.
Posted on June 16, 2012, in Economics and tagged Austrian economics, business cycle, Economics, J.B. Say, Keynesianism, overproduction, rothbard, Say's Law, underconsumption. Bookmark the permalink. 2 Comments.