Discuss Keynes’s critique of Say’s law

Say’s Law” is often defined as “supply creates its own demand,” which means that everything produced can be sold and sold at a price that will cover the costs of producing it – and that every labourer is worthy of his hire, and wanting it, will find himself hired. The Say’s law has been very influential, but is still controversy. According to Say’s law, Keynes said that there can never be a shortage of aggregate demand, full employment always guaranteed. But does it tell the whole story? In this essay I will discuss Keynes’s critique of Say’s law. First of all, let us look at the Say’s law in more details.

In a barter economy where trade through exchanging good for good. For Walras’s law, for each individual, the value of supply should equal to the value of goods demanded in return. Hence, summing over all individuals and (n) goods, we could use the formula as follows: , where are market demand, supply for good i, is the price of good i in terms of an arbitrary numeraire. Obviously, in a barter economy, there cannot be a shortage of demand, which follows Say’s law.

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However, if we want to represent these in a money market, we shall use this formula: , where and are the flow demand and supply of money. s planned additions to money holdings. If this follows Say’s law, the total value of demand for goods and services equals the total value of supply under all conditions. In other words, is always zero. However, people have questioned quite a lot on Say’s law. Firstly, people argue that in a money economy, if say’s law works, demand should equals to supply, just like what we have said above, Dn should equals to Sn. However it is not possible due to the fact that people clearly do change their money holdings.

In addition, people also argue that there are strong equilibrating mechanisms between demand and supply, so it is possible for Dn=Sn. Some C19 (and modern) economists say that demand/supply for goods depends only on ‘real’ factors while money only affects nominal price level. This implies Say’s identity. Some also argue that this just cannot be true because monetary change can only affect price level via demand and supply for goods. is not always zero. For example, when people have too much cash they spend or lend it, as a result, this raises price level.

Secondly, people try to explain the invalidity of say’s law from another side. If demand equals to supply, the reflection to individuals should be that their wages should equals to the value of output. Obviously, this cannot be true because the value of output is more than their wage bill. Otherwise not a single firm could possibly make any profit. So workers’ spending won’t account for all of output. People just can not formulated a clear answer to this. At the same time, some people mentioned that another important issue: investment.

Historically, Malthus agreed with Smith that savings are invested, hence used to employ productive workers. But investment will increase output; as a result, it has worsened the gap between consumption and output. So people have suggested that, the unproductive people can possibly fill the gap. Furthermore, people like Keynes and other economists had made further discussion, for Keynes, he believed that (1) Say’s Law declares that there is “no obstacle” to full employment; (2) Full employment does not exist in our present economy; therefore, (3) Say’s Law does not hold.

Keynes believed that the breakdown of Say’s Law came about because of a lack of aggregate demand, which comes about by the disequilibrium of planned savings and planned investment. Savings was a function of current income, while investment was a function of a number of things, not the least of them being the “animal spirits” of the investors. In other words, full employment of resources is not a given in the economy. In the Keynesian system, savings and investment are not two sides of the same coin, but rather two separate and unequal activities.

Full-employment equilibrium itself is unnatural for Keynes. He later stated that Full employment “can only exist when, by accident or design, current investment provides an amount of demand just equal to the excess of the aggregate supply price of the output resulting from full employment over what the community will choose to spend on consumption when it is fully employed. John Stuart Mill started his argument by saying saving is consumed by productive workers, Consumption takes place to the greatest extent which production admits of.

Because in a barter economy, No overall shortage of demand is possible, so Say’s law might hold. In money economy sell for money first, spend money later. Mill agrees that all income spent or invested, but not necessarily immediately. For instance, in a stagnation period, people might delay their purchasing, demand falls, in a economy boom, everything will be sold quicker, and money will be spent hurry. So the main stimulus are to spending is raising prices. When general price level rises but people don’t realize it (they think their own prices are rising) expand output, reinvest immediately.