How I learned to love Say's Law

[Acala]

RPF has been an amazing learning experience for me over the years. Sometimes by direct passing of information and sometimes by raising questions that send me away to learn on my own.

Recently, a poster mentioned Say's Law. I had heard of Say's law, but never really understood it. And the classical statements of the law are rather obscure. Anyway, I went off to try and understand it and now I think I get it. And it's very cool. Because it is so important to understanding some fundamental problems with Keynesianism and the whole notion of stimulating the economy with cash, I thought I would report back on the way I came to understand it.

Because we are used to thinking about supply and demand as opposing sides of a given transaction, we (by which I mean mainstream economists, politicians, media, and the public) have come to think of them as different entitites in the economy. As a result, we have come to the erroneous conclusion that these two entitites can be out of balance and that one side or the other can be stimulated like putting your finger on one pan of a scale.

To see through this illusion, let's look at the atomic level of the economic organism. Imagine Fred the Fisherman and Windsor the Chairmaker living in a barter economy. Fred goes out in his boat and catches enough fish to feed his family and then goes on to catch surplus fish to bring to the market. He has thus produced a supply of fish for the market. Likewise, Windsor makes more chairs than his family can use and brings the surplus to market. Windsor has thereby produced a supply of chairs for the economy at large. But when Fred comes to market with his basket of fish, he intends to give those fish to Windsor in exchange for a chair. Seen from the other side, Windsor brings his chair to market with the intent of exchanging it for Fred's basket of fish. So, while Fred's fish and Windsor's chair constitute a supply of goods, they simultaneously create DEMAND for goods! Fred's production of fish creates demand for Windsor's chair and Windsor's production of a chair creates a demand for Fred's fish. So supply and demand are one and the same thing! Production constitutes demand.

Using money as a fungible medium of exchange allows more complicated and remote transactions, but does not alter the fact that production and demand are the same thing.

So why does this matter? It matters because it demonstrates clearly why trying to stimulate demand by creating money must ultimately fail. The fact that government and banks can create money and buy goods with that money only means that they have figured out a way to steal or borrow production from somewhere else and have thereby impoverished someone in exchange for their gain. It also puts the lie to the Keynesian idea of aggregate supply and demand imbalance, since in the aggregate, supply and demand are the same thing!

Real economic growth comes from production of goods and services, which is both supply and demand. It cannot come from an influx of phony cash.

 

[jclay2]

RPF has been an amazing learning experience for me over the years. Sometimes by direct passing of information and sometimes by raising questions that send me away to learn on my own.

Recently, a poster mentioned Say's Law. I had heard of Say's law, but never really understood it. And the classical statements of the law are rather obscure. Anyway, I went off to try and understand it and now I think I get it. And it's very cool. Because it is so important to understanding some fundamental problems with Keynesianism and the whole notion of stimulating the economy with cash, I thought I would report back on the way I came to understand it.

Because we are used to thinking about supply and demand as opposing sides of a given transaction, we (by which I mean mainstream economists, politicians, media, and the public) have come to think of them as different entitites in the economy. As a result, we have come to the erroneous conclusion that these two entitites can be out of balance and that one side or the other can be stimulated like putting your finger on one pan of a scale.

To see through this illusion, let's look at the atomic level of the economic organism. Imagine Fred the Fisherman and Windsor the Chairmaker living in a barter economy. Fred goes out in his boat and catches enough fish to feed his family and then goes on to catch surplus fish to bring to the market. He has thus produced a supply of fish for the market. Likewise, Windsor makes more chairs than his family can use and brings the surplus to market. Windsor has thereby produced a supply of chairs for the economy at large. But when Fred comes to market with his basket of fish, he intends to give those fish to Windsor in exchange for a chair. Seen from the other side, Windsor brings his chair to market with the intent of exchanging it for Fred's basket of fish. So, while Fred's fish and Windsor's chair constitute a supply of goods, they simultaneously create DEMAND for goods! Fred's production of fish creates demand for Windsor's chair and Windsor's production of a chair creates a demand for Fred's fish. So supply and demand are one and the same thing! Production constitutes demand.

Using money as a fungible medium of exchange allows more complicated and remote transactions, but does not alter the fact that production and demand are the same thing.

So why does this matter? It matters because it demonstrates clearly why trying to stimulate demand by creating money must ultimately fail. The fact that government and banks can create money and buy goods with that money only means that they have figured out a way to steal or borrow production from somewhere else and have thereby impoverished someone in exchange for their gain. It also puts the lie to the Keynesian idea of aggregate supply and demand imbalance, since in the aggregate, supply and demand are the same thing!

Real economic growth comes from production of goods and services, which is both supply and demand. It cannot come from an influx of phony cash.

Thanks for this. Very appreciated. + rep. Funny how the economic authoritarians never talk about boosting supply to spur demand.

 

[Danan]

Say's position was the only accepted theory of exchange for centuries. "Mainstream"-economists would ridicule anybody suggesting that there can be demand without preceding production creating that demand. But this was the very intention of Keynes - refuting Say's law. Roger Garrison talks about that in his excellent lectures. There is also a brilliant essay written by Steven Kates on Say and Keynes: http://mises.org/journals/qjae/pdf/qjae13_4_1.pdf

I've always seen economics through the lense of Say's law, even before I've ever heard about it. Every economics student comes across the famous Keynesian equation Y = C+I+G (let's leave out net exports for now) during their first year. And there is nothing wrong with this formula so far. One is also told that investment is equal to savings (which is income not spent on consumption). And even though some savings might not translate into investment, it seems quite reasonable to accept it in order to simplify the problem. Up to this point there is no Keynesian cross. Supply is equal to demand. Increase G and you decrease C and I. Increasing I can only come from decreasing C and vice versa. It's totally in line with Say.

What always annyoed me, however, was that in the very next step everything we assumed above is completely ignored and disregarded. Suddenly investment is not equal to savings anylonger (which was never mentioned during my classes), but a mere function of interest rates, among other things. Also, consumption is only partly dependend on your income. Or to put it differently, even if the whole society wouldn't produce anything at any time at all, there would still be constant consumption. Consumption of what?! That's so blatently stupid, it's hard to get one's head around it. But those are the two key features of Keynesian theory that allow for the multiplier effect. Only because of the disconnect between savings and investment and the assumption of consumption out of thin air do we create an intersection between demand and supply curve. Without them, demand IS supply, which is essentially Say's law.

One can't consume what has not been produced. Supply creates demand, because demand is willingnes and ability to pay a certain price for a certain amount of goods. Where does this ability come from? It's your wealth that was created beforehand.

 

[Seraphim]

Yes, exactly.

Keynesians of the modern type are entirely backwards. Consumption does not drive economic activity, production does.

 

[Zippyjuan]

Boosting supply works if there is unmet demand. If there is not unmet demand, boosting production is wasted and won't work. If say there are 100 people who want to buy a car and Ford makes 100 cars a year, if they up their production to 200 cars, will they be able to sell all 200 cars? Not if only 100 people still are willing and able to buy them.

If the theory worked, there would never be any excess supply of things. Increasing the supply would simply create more demand for them.

Best line from the post:

which is both supply and demand.

It is true that if companies start hiring people or give them raises that then people will have more money to spend on goods and services- including the goods that employer produces- that would be good for the overall economy most certainly- but in the real world, the businessman is concerned about his own profits not social welfare so he won't increase his productivity unless he believes he can sell more goods and make more profits off of them. Unless his DEMAND changes, he is not going to change his SUPPLY.

 

[heavenlyboy34]

Thanks for this. Very appreciated. + rep. Funny how the economic authoritarians never talk about boosting supply to spur demand.

Except WRT the money supply.

 

[Danan]

Boosting supply works if there is unmet demand. If there is not unmet demand, boosting production is wasted and won't work. If say there are 100 people who want to buy a car and Ford makes 100 cars a year, if they up their production to 200 cars, will they be able to sell all 200 cars? Not if only 100 people still are willing and able to buy them.

I believe you don't really understand the point. It's easy to get confused by a profit/loss perspective. Let's start out in a Robinson-Crusoe-economy where nobody produces anything. Let's say there are two people on the island, A and B. One of them, person A, starts to catch fish in order to trade it (he doesn't really like fish). He obviously increases the fish supply, but does he also add demand to the economy? Yes he does. Demand for what? Demand for everything. Everything but fish! Demand is willingnes and ability to buy a certain amount of a good or service to a certain price (no matter if those goods exist at all). He is now willing to trade in all his fish for any good offered to him, since he doesn't like to eat it himself. So the demand for every good (except fish) priced in fish increased.

The supply for all other goods is zero currently, but that doesn't change the fact that he created demand. Now B, who loves fish, knows that there is demand for many goods and can start to produce one of them, in order to trade with A. Does the fact that B starts to collect coconuts increase demand for coconuts? No. But it does increase demand for fish, which was zero and now is a certain number of coconuts for any given amount of fish.

 

[Zippyjuan]

If the other guy also doesn't like fish then catching more fish doesn't do any good for the economy. He can catch as many as he wants to but won't be able to get rid of any of them.

Let's say he does like fish. How many can he use a day? If the first person catches 100 fish a day, can the second person eat 100 fish a day? Supply was certainly increased. Can he get the other guy to eat more fish to use up the newly created supply?

 

[Danan]

Back in our advanced economy prices, profits and losses play important roles when analyzing supply and demand further. One major difference is that there is also supply and demand for factor inputs. On the island there are no alternative uses for any factor before they start producing so the only real cost of production is their time. Normally there is competition for those inputs. Opportunity costs, prices and profits/losses ensure that factor inputs are allocated to their most efficient use to maximize consumers' utility. But that doesn't mean that unprofitable endevors didn't create demand. They only created less than could be created otherwise and producing them was more expensive than what came back in revenues. It's still "better" to produce 100 cars than nothing instead. Or to put it differently, producing 100 cars adds demand for other goods the market, according to the market value of those cars.

Losses only show that there are other, better uses for those inputs. Were there no other uses, it would be a profitable endevor, because the only reason those inputs cost anything at all, is because other people value them too (and more than what you are able to transform them into).

That being said, "boosting supply", as understood by many supply-side economists is not necessarily the way to go either. It's not as if you could easily "add" to aggregate supply per decree. Most of the time you would only disallocate resources to more inefficient uses. The only thing growing supply in the long term is technological progress (and changes like more specialization through globalization, etc.).

 

[Danan]

If the other guy also doesn't like fish then catching more fish doesn't do any good for the economy. He can catch as many as he wants to but won't be able to get rid of any of them.

It's first of all an academic issue. The statement that supply creates it's own demand is true and sufficiently proven. Say is right, Keynes is wrong.

It is obviosly true that if B doesn't like fish either nor A coconuts, that no trade will come about and no wealth was being created through production. Supply and demand dont match. But one is not greater than the other.

In reallity matching supply with demand is more important than increasing supply/demand by all means. The best way to do that is via profits/losses and prices, or more generally free markets. Politics only creates more of a mess in the process. And as von Mises has shown, in its purest form socialism is entirely inherently incapable to match supply and demand. Even though they can increase supply (as they did) people don't necessarily benefit from it, because the wrong goods are being produced.

 

[Zippyjuan]

You are right- it takes both supply and demand. You can't simply increase supply and expect that to automatically increase demand. If you give people more money- either through gifts or higher wages- they will likely increase their demand for things- though this effect can depand on where you are on the income scale. If you are a billionaire, you probably have everything you may want. If you are poor, having more money can mean you can now afford more of the things you wanted or needed. If poor person earns twice as much, that will help the economy. If the billionaire gets another billion, it won't do much.

 

[Danan]

You are right- it takes both supply and demand. You can't simply increase supply and expect that to automatically increase demand. If you give people more money- either through gifts or higher wages- they will likely increase their demand for things- though this effect can depand on where you are on the income scale. If you are a billionaire, you probably have everything you may want. If you are poor, having more money can mean you can now afford more of the things you wanted or needed. If poor person earns twice as much, that will help the economy. If the billionaire gets another billion, it won't do much.

You need to get away from evaluating all goods in monetary units. Producing any good increases its supply. To put it differently, aggregate supply has increased by X goods Y, or by it's money equivalent. It also increases overall demand, by whatever this good is worth priced in other goods.

If nobody wants to buy those 100 cars at all, aggregate demand didn't increase by producing those cars. But aggregate supply didn't increase either, since those cars aren't worth anything. Bot increased by the value of 100 cars, which just happens to be zero.

When you have to think in monetary units, it's still true that an increase in supply is also an increase in demand, by exactly the same amount, when priced in money.

 

[Stallheim]

You need to get away from evaluating all goods in monetary units. Producing any good increases its supply. To put it differently, aggregate supply has increased by X goods Y, or by it's money equivalent. It also increases overall demand, by whatever this good is worth priced in other goods.

If nobody wants to buy those 100 cars at all, aggregate demand didn't increase by producing those cars. But aggregate supply didn't increase either, since those cars aren't worth anything. Bot increased by the value of 100 cars, which just happens to be zero.

When you have to think in monetary units, it's still true that an increase in supply is also an increase in demand, by exactly the same amount, when priced in money.

Mises point about Entrepreneur is good too: He faces a market of unlimited general wants, appetites what have you for more, better, cheaper of a myriad goods and services. The Entrepreneur creates a specific offering, or answer to the general unlimited wanting, that thing (or service) can now be demanded. He might get it right or he might get it wrong, as Danan mentioned earlier he might not be providing a valuable enough product to justify the cost when measured against competing uses for those resources, if this is the case he loses money as factor prices eat up his bottom line. Mises says that for the Entrepreneurs it is a zero sum game because they are all competing to use that limited supply of scarce resources in anticipation of a possibility that what they envision will be demanded sufficiently to make them a profit over the input costs.

 

[ClydeCoulter]

Increasing supply (or a new product) would also increase the hours worked (adding in money and hirlings to the equation), so, if considering that work is paid for, they now can buy more goods from others that they could not afford before, and create more demand (which will create jobs (ie production) and increase demand again...)

 

[ClydeCoulter]

You are right- it takes both supply and demand. You can't simply increase supply and expect that to automatically increase demand. If you give people more money- either through gifts or higher wages- they will likely increase their demand for things- though this effect can depand on where you are on the income scale. If you are a billionaire, you probably have everything you may want. If you are poor, having more money can mean you can now afford more of the things you wanted or needed. If poor person earns twice as much, that will help the economy. If the billionaire gets another billion, it won't do much.

Bill Gates proved that supply can create demand if you can bring prices down in expectation of a mass increase of sales. Windows 95 and his negotiations with memory and hard drive manufacturers to slash their prices and increase volume.

edit: And thanks Acala, for the overview of Say's Law

 

[CaptUSA]

If poor person earns twice as much, that will help the economy. If the billionaire gets another billion, it won't do much.

Oh, rlly?

What does that billionaire do with his money? throwing it under his mattress?

Chances are that he is investing his capital into another business that is using it to create more wealth. This most certainly grows the economy. And since this billionaire is investing wisely, he is putting into a successful venture and not some gov-created boondoggle. Of course, he may put it into a bank. Where they would have more reserve to lend out to people looking to grow their wealth.

Zippy, if you think as capital only being good when it is on the demand side, then you are missing the whole point. Capital on the supply side creates demand. More productivity is the answer.

 

[The Gold Standard]

Increased supply creates demand by lowering the price. If the fisherman on the island increases his production to 100 fish a day, if there is only one customer for them then they will be really cheap, so the other guy may find a way to use or store all 100 of them.

If you stimulate the demand side by debasing the money, and therefore propping up prices, then you defeat the purpose. If you stimulate the supply side by debasing the money, you get the same result. Increased production resulting from investing real, saved capital is the way to stimulate demand.

 

[nayjevin]

QFT

If the theory worked, there would never be any excess supply of things. Increasing the supply would simply create more demand for them.

 

[Danan]

If the theory worked, there would never be any excess supply of things. Increasing the supply would simply create more demand for them.

QFT

Just in order to point it out one last time, since not all of you seem to get it:

This thread is about Say's law. Say's law is a basic economic principle that was (rightfully) regarded as a fundamental truth for a long period of time. Keynes managed to (unsoundly) "abolish" it, because it was a thorn in his side, disrupting his plans to centrally plan economies.

Say himself explained what later became Say's law the following way, "products are paid for with products" or even more famous, "the supply creates its own demand". This is crucial. Standard Keynesian macro (which is what all modern neo-classical macroeconomics essentially is) is based on the believe that supply and demand are two seperate functions, intersecting each other dependend on many factors that politicians can influence. Thus it's a central bank's and government's responsibility to create policies that boost that intersection as high as possible, for the largest possible economic wellbeing, according to them.

Why this is wrong and why Say was entirely correct was already explained earlier. Only what was produced earlier can be traded in for other goods later. There is no consumption without previous production. One's supply of goods is what enables them to demand other goods with the same market value (Say didn't know about subjective values yet, so that can get a little bit confusing, but it's good enough for our purposes to describe value that way). Demand is desire and ability to buy at a given price. What determines the amount of goods a person is able to buy? It's the market value of the supply of goods they are willing to trade in in return.

Say is absolutely correct with his statement, "the supply creates its own demand". This point can not be stressed enough. If we manage to get this point across, we can destroy the importance of Keynes in economic theory once and for all. That would mean an end for the justification of the Fed and active fiscal policy.

 

[Danan]

If the theory worked, there would never be any excess supply of things. Increasing the supply would simply create more demand for them.

Increasing the supply of good A does not increase demand for good A. That is not what Say meant. Increasing one's supply of A at the same time increases one's aggregate demand for all other goods.

New products with a positive market value were created that did not exist before. Since the only thing that limits one's aggregate demand is ability to pay, not willingnes, increasing ability to pay for additional goods and services also increases demand for them. Thus producing stuff "worth" X (on the market) also increases demand for all the other goods by X.