Say's Law of Market

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Say's Law of market is one of the major block of classical economics devised by French economist JB Say. He devised the fact that whatever demanded would be supplied automatically in exchange of money. So there will not be any overproduction or unemployment in an economy. It states that Supply creates its own demand.

Case of Barter economy

In case of barter economy, Say’s law hold obvious. Whatever produced in an economy would be automatically consumed or they are sold in the markets. Savings and Investment are not a separate process but they go hand in hand. Every amount supplied constitutes its own demand. For example, there is the possibility of contraction of oversupplied goods and the expansion of under supplied goods and hence the market will clear because there is possibility of variations in an exchange ratio.

Case of Money using economy

Say devised his theory which would be applied in barter system only. But the classical economists later find out that such situation would be present even with the presence of money. The conditions under which Say’s law of market may be used in money using economy are briefly discussed below:

  • Money is just as the medium of exchange. In such condition, the demand for money is exactly equal to the money Supply.

  • Aggregate cost of production is equal to the aggregate factor income which is equal to the aggregate demand in the economy.

According to the above figure, the aggregate supply of money in an economy (money in circulation) is used for the payment of factors of production. Which is the payment to  the employees/Laborers ( Wages and Salaries), Payment to the land (Rent) , Payment to the capital (Interest) and payment for entrepreneurs ( Profit). These factors of production then either spend it in the consumption process or flow it into the financial markets through financial intermediaries (banks, insurance companies etc.)  They do not hold the money idle. Anyhow the money which comes to the market goes bank into the market and the equilibrium situation is present in the market.

Regarding the equality of savings and Investment, the classical economists have developed theory of interest and investment.

 

 

Investment and interest rate are negatively correlated. Higher the rate of interest, the entrepreneurs will be discouraged to invest and they start holding their money. So the investment demand curve is negatively sloped. Similarly, Savings is the supply of loan able fund and are positively sloped. Higher the interest rate higher will be the savings.

By any kind of exogenous disturbances, rate of interest rises to r2, the demand for loan able fund will be a and supply of loan able fund will be b. There will be shortage of loan able fund in the economy. The central banks will then reduce the rate of interest as an incentive to the investors. So, more investors will invest in the market and the loan able fund will be at equilibrium at point e0  where, rate of interest is r0 and amount of loan able fund is Q0

Now, suppose that market rate of interest falls to r1 Where the supply of loan able fund is excess comparing to the demand of loan able fund. So there is excess supply of loan able fund in the market. To manage such disequilibrium, a central bank of the country raises the interest rate. The excess money which was held idle in the bank now flows into the market through purchase of commodity by the consumer. Then economy turns back to equilibrium position.

 

 

 

 

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