The Problem of Say's Law

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For several decades, the theories of John Maynard Keynes replaced the classical theory which had dominated policy-making for more than a century until the Great Depression. This brought things full circle, because the classical economists had succeeded the Mercantilists. And the Mercantilists were proto-Keynesian in their contention that, left to itself, the economy has a tendency toward “under-consumption,” which, they argued, must be combated by public spending, combined with measures to increase the money supply.

The classical economists replied that consumption can look after itself. No one, they said, would go to the trouble and expense of producing goods, unless they planned either to consume them or exchange them for good which they would ultimately consume.

Jean-Baptiste Say’s “Law of Markets” says, in effect, that goods exchange for goods: the goods produced, taken together, provide the value with which to purchase themselves. “The creation of a new product is the opening of a new market for other products, [while] the consumption of destruction of a product is the stoppage of a vent for them,” Say wrote (A Treatise on Political Economy, Chapter XV).

To emphasize this point, the classical economists elaborated a barter theory of exchange. They also had a theory of money, which went back to David Hume, but the two theories were not formally integrated. The classical economists emphasized that, although money is only half of every exchange, it has only a temporary role in facilitating the exchange of goods. “Money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found, that one kind of commodity has been exchanged for another,” Say argued (idem).

Say himself recognized that total demand for goods would not exactly equal total supply if people sold more goods than they bought, in order to increase their holdings of money. But he emphasized that, sooner or later, supply and demand for goods would balance. First, because more money would be forthcoming: “There is always money enough to conduct the circulation and mutual exchange of other values, when those values really exist,” he said. “[M]erchants know well enough how to find substitutes for the product serving as the medium of exchange or money: and money itself soon pours in, for this reason, that all produce naturally gravitates to that place where it is most in demand.” (This was Hume’s theory.) Second, because hoarded money would be spent sooner or later: “Even when money is obtained with a view to hoard or bury it, the ultimate object is always to employ it in a purchase of some kind. The heir of the lucky finder uses it that way, if the miser do not; for money, as money, has no other use than to buy with” (idem). To anticipate things a bit, we not that Say’s answer depends on some empirical arguments about the supply and demand for money.

Others, however, recognized that the Mercantilists had not been fully answered. The earliest correction of Say’s Law seems to belong to John Stuart Mill. But it is contained in a little-noticed article which was published, I believe, only after his death (“Of the Influence of Production on Consumption,” in Some Unsettled Questions of Political Economy).

Restating Say’s Law, Mill observes: “Nothing  is more than that it is produce which constitutes the market for produce, and that every increase in production, if distributed without miscalculation among all kinds of produce in the proportion which private interest would dictate, creates, or rather constitutes, its own demand.”

However, Mill observes, it would seem that Say’s Law “contradicts those obvious facts which are universally known and admitted to be not only possible, but of actual and even frequent occurrence” – namely, the existence of rises and falls in the price level, and of economic upswings and recessions. These conditions necessarily reflect an inequality between total supply and total demand.

Say’s Law, Mill notes, “is evidently founded on the supposition of a state of barter; and, on that supposition, it is perfectly incontestable. When two persons perform an act of barter, each of them is at once a seller and a buyer. He cannot sell without buying.”

“If, however, we suppose that money is used, these propositions cease to be exactly true…. [T]he effect of the employment of money, and even the utility of it, is that it enables this one act of interchange to be divided into two separate acts or operations… Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another.”

For Say’s Law to be strictly true, Mill concluded, “money must itself be considered as a commodity. It must, undoubtedly, be admitted that there cannot be an excess of all other commodities, and an excess of money at the same time.” To make such an argument, Mill says, “involves the absurdity that commodities may fall in value relatively to themselves.”

In this way, Mill anticipates what is known as Walras’ Law, but does not work it out. The proof that “money must itself be considered as a commodity,” since “there cannot be an excess of all other commodities, and an excess of money at the same time,” is generally credited to Leon Walras. Wealth can be divided into three categories – money, claims, and goods. Walras proved that any excess demand for money must equal the sum of the excess supply in the other two markets. It remains true that you can’t sell without buying, if you include money among the articles bought and sold.

Next: The Problem with Keynes


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