Say’s Law is a theory developed by the French economist Jean-Baptiste Say in 1803, and has become one of the main assumptions in classical economics.
The law is often misinterpreted as “supply creates its own demand”, as quoted by John Maynard Keynes in The General Theory of Employment, Interest and Money (1936). More correctly, it states that the act of production will generate enough income for an equivalent amount of demand for other productions.
Imagine a situation where a firm produces a type of good. If the owner of the firm sells the good, this production creates wages for workers and income for the owner, which they can then use to buy other goods.
The theory came under criticism in the 1930s Great Depression, especially by John Maynard Keynes. This is because if Say’s Law is true, situations similar to that of the Great Depression – when aggregate demand fell below the productive capacity of the economy causing high unemployment and a prolonged recession – cannot exist. Keynes therefore argued the following points:
Classical economics – This is a school of economic thought that believes free markets regulate themselves, and that the economy always moves towards full employment without the need for government intervention. Famous economists of this school of thought include Adam Smith, David Ricardo and Thomas Malthus.
Demand – The quantity of a good or service that people are willing and able to buy.
Full employment level – This is the maximum potential output for the economy where every unit of capital and labour is being utilised.
Invisible hand – An expression coined by the economist Adam Smith to show that when people acted selfishly and bought products that they wanted, society on the whole would be better off because only the goods and services that people wanted would be produced. Therefore when people act in their own self-interest they are actually acting in the most socially optimal way.
Supply – The quantity of a good or service offered for sale.