Transcript exchange and barter

Say’s Law of Markets
1. Classical Theory of Employment
1. Say’s Law of Markets
⎈ Say’s law of markets is the core of classical theory of
employment.
⎈ A famous French Economist Jeane Baptiste Say
enunciated the formal statement that “Supply creates
its own demand.”
⎈ It implies that the supply of goods generates sufficient
income to create demand for goods equal to its supply.
⎈ Therefore, there is no possibility of overproduction and
unemployment in the economy.
⎈ Even if there is some unemployment in the short-run,
the economy automatically tends towards full
employment in the long-run.
 Assumptions of Say’s Law of Markets
⎈ There is free market economy.
⎈ No government intervention.
⎈ Automatic adjustment of economic system due to
flexibility of wages, interest and prices.
⎈ Extent of market is limitless.
⎈ Closed economy, no trade links with any other
country,
⎈ Money is only a medium of exchange.
⎈ Validity of long-run,
⎈ Optimum allocation of resources,
 Important facts of Say’s law
⎈ Production creates Demand for goods.
With the use of inputs in production process,
income is generated. This income is distributed to the
owner of inputs which they ultimately spend on
purchasing goods for their use. This causes demand for
produced goods. This is how supply creates its own
demand.
⎈ Barter and monetized economy,
Say’s law holds good in barter economy. It is
because, goods are produced for self consumption or to
get other goods in exchange for the produce. When
people offer their produce in barter for other goods, they
create demand for the goods.
This law is also valid in monetized economy, In this
economy money is used to buy or sale goods and services.
The inputs used in production generate money incomes in
the form of wages, interest, rent and profits. The incomes
are spent on purchasing the goods produced. It creates
demand. It implies that if there is production, there is
income and if there is income, there is demand for goods
whose production creates income. Thus, supply creates its
own demand in monetized economy.
⎈ No general overproduction
Say’s law states that there is no general
overproduction. When there is an increase in production,
there is also increase in income of related factors.
Consequently new demand is created and there is no
general over production. General overproduction may
exist in the short-run but it is automatically adjusted by
the market forces of demand and supply in the long-run.
⎈ Saving and investment equality
Generally income is spent on consumption. When some
amount of income remains unspent on consumption or saved,
overproduction may exists. But it is rate of interest which plays
important role to make a decision for both the consumers and
producers about saving and investment. How much is to save
and how much is to invest, depend on rate of interest. The
interaction for demand for and supply of saving as a capital
determines equilibrium rate of interest in market at which the
equality between saving and investment is restored and there is
no over production.
⎈ Labour Market
Labour always seek a higher wage rate but it causes a fall
in demand for labour and rise in unemployment. In a free
market economy flexible rate of wages automatically restores
full employment through the interaction of demand for and
supply of labour
 Implications of Say’s Law
The implications of the law are as follow
⍟ Full employment in the economy
According to Say’s law there is full employment in
the economy. It is because increase in production means
increase in employment and production continues until
the full employment is reached. In such a condition
production will be maximum.
⍟ Proper utilization of resources
This law is based on full employment in the
economy. According to which the proper utilization of idle
resources are ensured which will further help to produce
more and also generate more income.
⍟ No general overproduction
There is no general overproduction and no
unemployment. Increase in production generates income
for inputs and further demand is created for the produce.
⍟ Self adjustment mechanism
According Say’s law the self adjustment mechanism
brings up equilibrium in different markets.
So
disequilibrium is a temporary situation. In a capital market
equality between saving and investment is restored by the
flexible interest rate while in labour market equality
between demand for and supply of labour is maintained
by the wage rate.
⍟ Wage cut creates full employment
This law assumes that wage-cut helps to restore full
employment by reducing production cost and price level
and increasing demand for goods. It denies the wage
rigidity policy in the economy.
⍟ Neutral role of money
This law is based on barter system where goods are
exchanged for goods. There is also assumed that money is
just a medium of exchange; it does not affect the
production process. So the role of money is neutral.
 Criticism of Say’s Law of Markets
Say’s law was criticized by J. M. Keynes on the
following grounds.
 Supply does not create its demand
Say’s law states that supply creates its demand but
Keynes disagrees with this view. According to Keynes in
modern times, demand does not increase as much as
production increases. It is also not possible to consumes
the goods produced in domestic economy.
 Self-adjustment is not possible.
Say’s law assumes that shelf-adjustment mechanism
maintains full employment in the long-run. But according
to Keynes employment can be increased by increasing in
the rate of investment not by shelf-adjustment mechanism
in the long run. Neither he was in favor of long-run nor he
believed that we are all alive in the long run.
 Money is not neutral.
Say’s law assumes that the role of money is neutral
and it does not effect the economic activities. Keynes
gives due important to money. According to him, money
is held for income and business motives. Individuals hold
money for unforeseen contingencies. Businessmen hold
cash in reserve for future purpose. So money is not
neutral, it affect economic activities.
 Overproduction is possible.
Say’s law denies the possibility of overproduction
but Keynes is in against it. He believes that whole factorincome is not spent. A portion of income is saved but it is
not automatically invested. Therefore, saving and
investment are always not in equality. Hence the
problems of overproduction and unemployment remains
in the economy.
 Need of state intervention
Say’s law is based on free market policy but Keynes
has focused on the need of the intervention of state at
times of overproduction and mass unemployment through
fiscal and monetary policies.
 Wage-cut is not favorable
Supporting says law, Pigou favored a wage-cut policy
to solve the unemployment problem. But Keynes is not in
favor of wage-cut policy. He believes that wage-cut brings
deficiency in aggregate demand which increases
unemployment instead of removing it. So wage-cut is not
favorable.
 Saving and investment equality through income
Keynes opposes Say’s view that saving and
investment equality is restored through rate of interest.
He advocates, it is change in income rather than rate of
interest which bring about equality in them.
 Unemployment Situation
According to Keynes full employment is a special
case because in capitalist economies, unemployment is is
fount existing. Capitalist economies are not found
functioning according to says law and supply always higher
than its demand. Therefore many workers are willing to
work at current wage rate but remain unemployed.