Monetary Central Planning and the State, Part 18: Say's Law of Markets and Keynesian Economics

In the preface to The General Theory of Employment, Interest and Money, John Maynard Keynes stated that “the composition of this book has been for the author a long struggle of escape … a struggle of escape from habitual modes of thought and expression.” What Keynes struggled to escape from were the commonsense foundations of economics.

From Adam Smith in the 18th century to the Austrian economists of the 20th century, economics has developed and been refined into the study of human action and the logic of human choice. Over 200 years, economists came to more clearly understand that nothing happens in society or in the market that does not first begin with the actions and decisions of individuals. Indeed, the market is nothing more than a summarizing term to express the arena in which multitudes of individuals meet and interact as suppliers and demanders for purposes of mutual gains through trade.

Each individual has various goals or ends he would like to achieve. To attain them he must apply various means that may be at hand to bring those desired ends into existence through production. But man finds that, unfortunately, the means at his disposal are often insufficient to satisfy all the uses he has for them. He faces the reality of scarcity. He is confronted with the necessity to choose. He must decide which of the desired ends he prefers more and which he prefers less. And then he must apply the means that he has to achieve the more highly valued ends and leave other, less valued, ends unfulfilled, either for a day or forever.

In his state of disappointment, man looks around to see whether there are ways to improve his situation. He discovers that there are others who face the same frustrations of unsatisfied ends, like himself. Sometimes he finds that those others have things that he values more highly than what is in his possession, and they in turn value more highly what he has than what they own. A potential gain from trade arises, in which each can be better off if he trades away what he has for what the other has.

But how much of one thing will be exchanged for another? This will be determined through the traders’ bargaining in the market. Finally, they may agree upon terms of trade and establish a price at which they exchange one thing for another: so many apples for so many pears; so many bushels of wheat for so many pounds of meat; so many pairs of shoes for a suit of clothes.

Trade becomes a regular event through which men improve their circumstances through the process of buying and selling. Appreciating the value of these trading opportunities, men begin to specialize their productive activities and create a system of division of labor, with each trying to find that niche in the growing arena of exchange in which they have a comparative advantage in production over their trading partners. As the market expands and widens, a growing competition arises among the buyers and sellers, with each trying to get the best deal possible as a producer and a consumer. The prices at which goods are traded come more and more to reflect the contributing and competing bids and offers of many buyers and sellers on both sides of the market.

The more complex the network of exchanges, the more difficult becomes the direct barter of goods one for another. Rather than be frustrated and disappointed in not being able to directly find trading partners who want the goods they have for sale, individuals start using some commodity as a medium of exchange. They first trade what they have produced for some particular commodity and then use that commodity to buy the things they desire from others. When that commodity becomes widely accepted and generally used by most, if not all, transactors in the market, it becomes the money-good. (See “Monetary Central Planning and the State, Part V,” Freedom Daily, May 1997.)

It should be clear that even though all transactions are carried out through the medium of money, it is still, ultimately, goods that trade for goods. The cobbler makes shoes and sells them for money to those in the society who desire footwear. The cobbler then uses the money he has earned from selling shoes to buy the food he wants to eat. But he cannot buy that food unless he has first earned a certain sum of money by selling a particular quantity of shoes on the market. In the end, his supply of shoes has been the means for him to demand a certain amount of food.

This, in essence, is the meaning of Say’s Law, named after the 19th-century French economist Jean-Baptiste Say. Say called it “the law of markets.” Unless we first produce, we cannot consume; unless we first supply, we cannot demand.

But how much others are willing to take of our supply is dependent upon the price at which we offer it to them. The higher we price our commodity, other things held equal, the less others will be willing to buy of it. The less we sell, the smaller may be the money income we earn; and the smaller the money income we earn, the smaller our financial means to demand and purchase what others are offering for sale. Thus, if we want to sell all that we choose to produce, we must price it correctly, i.e., at a price sufficiently low that all of it we offer is cleared off the market by potential demanders. Pricing our goods or labor services too high, given other people’s demands for them, will leave part of the supply of the good unsold and part of the labor services offered unhired.

On the other hand, lowering the price at which we are willing to sell our commodity or services will, other things held equal, create a greater willingness on the part of others to buy more of our commodity or hire more of our labor services. By selling more, our money income can increase; and by increasing our money income, through correctly pricing our commodity or labor services, we increase our ability to demand what others have for sale.

Sometimes, admittedly, even lowering our price may not generate a sufficiently large increase in the quantity demanded by others for our income to go up. Lowering the price may, in fact, result in our revenue or income’s going down. But this, too, is a law of the market: what we choose to supply is worth no more than what consumers are willing to pay for it. This is the market’s way of telling us that the commodity or particular labor skills we are offering for sale are not in very great demand. It is the market’s way of telling us that consumers value more highly other things that they could buy instead.

It is the market’s way of telling us that the particular niche we have chosen for ourselves in the division of labor represents one in which our productive abilities or labor services are not worth as much as we had hoped. It is the market’s way of telling us that we need to move our productive activities into other directions, representing lines of production where consumer demand is greater and in which our productive abilities may be valued more highly.

Is it possible that consumers might not spend all they have previously earned from selling goods on the market? Is it possible that some of the money earned will be “hoarded,” so there will be no greater demand for other goods and hence no alternative line of production in which we might find remunerative employment? Would this not be a case in which “aggregate demand” for goods in general on the market would be insufficient to buy all of the “aggregate supply” of goods and labor services being offered for sale?

The answer to this was already suggested in the middle of the 19th century by the English classical economist John Stuart Mill in a restatement and refinement of Say’s law of markets. In an essay entitled “Of the Influence of Consumption on Production” (1844), Mill argued that as long as there are any ends or wants that men desire that have not as yet been satisfied, there is always more work to be done. As long as producers adjust their supplies to reflect the actual demand for the particular goods which consumers wish to purchase, and as long as they price their supplies at prices consumers are willing to pay, there need be no unemployment of resources or labor for all those who are looking for work. Thus, there can never be an excess supply of all things relative to the total demand for all things.

But Mill admits that there may be times when individuals, for various reasons, may choose to hoard, or leave unspent in their cash holding, a greater proportion of their money income than is the usual practice. In this case, Mill argued, what is “called a general superabundance” of all goods is in reality “a superabundance of all commodities relative to money.” In other words, if we accept that money, too, is a commodity like all other goods on the market for which there is a supply and demand, then there can appear a situation in which the demand to hold money increases relative to the demand for all the other things that money can buy. This means that all other goods are now in relative oversupply in comparison to that greater demand to hold money.

To bring all those other goods offered on the market into balance with the lower demands for them (i.e., given that increased demand to hold money and the decreased demand for other things), the prices of many of those other goods may have to decrease. Prices in general, in other words, must go down, until that point at which all the supplies of goods and labor services people wish to sell find buyers willing to purchase them. Sufficient flexibility and adjustability in prices to the actual demands for things on the market always ensures that all those willing to sell and desiring to be employed can find work for themselves. And this, also, is a law of the market.

Free-market economists, both before and after Keynes, never denied that the market economy could face a situation in which mass unemployment exists and a sizable portion of the society’s productive capacity is left idle. But if such a situation were to arise, they argued that its cause was to be found in a failure of suppliers to price their goods and labor services to reflect what consumers considered them to be worth, given the demand for various other things, including money. Correct prices always ensure full employment; correct prices always ensure that supplies create a demand for them; correct prices always ensure the harmony of the market.

This was the reality of the law of markets from which Keynes struggled so hard to escape.

Categories: Freedom Daily Archive, Monetary Policy