Read this article to discover the eleven major criticisms against the Say’s Law of market.
1. Possibilities of Deficiency of Effective Demand:
It is assumed in Say’s Law that whatever is earned is spent either on consumption goods or on investment goods, thus, income is automatically spent at a rate which will keep all the resources employed.
All this, however, is not supported by actual facts, as the income is not automatically spent on consumption and investment. Keynes pointed out that there can be a deficiency in aggregate demand as all income earned in producing an output would not necessarily be used to purchase it.
Keynes argued that money is an important form of storing wealth. That part of the current income, which is not spent, saved and may go to increase individual’s holdings. Therefore, whatever is saved out of current income does not constitute investment, because the opportunities for investment are not unlimited. We cannot say definitely that whatever is saved is spent on investment goods rather it may go to swell the liquid assets of the individuals. In this way, there can be a shortage of aggregate demand and the claim of Say’s Law that aggregate demand cannot be deficient at full employment is entirely defeated.
The fallacy of Say’s Law is revealed by Keynes’s division of aggregate demand into investment and consumption for purposes of income analysis (Y = C + I). Keynes points out that the factors which determine consumption are quite different from the factors determining investment but together they constitute the aggregate demand and determine the level of income. Consumption is a function of current income, but it does not increase as much as the increase in income.
Investment, on the other hand, depends upon technological developments and the marginal efficiency of capital. It is, therefore, clear that the determinants of consumption and the determinants of investments are not interconnected in such a way as to ensure adequate aggregate demand.
Hence, total demand would not always be such as would guarantee adequate market for the output. The stability of the aggregate demand would be attained only when the gap between current income and current consumption is made up completely by the necessary amount of investment. Keynes, thus, found in the failure to spend current income on consumption and investment goods the cause of unemployment.
2. Prolonged Depressions—a Reality:
It is not uncommon to experience a ‘glut’ in the economy such as between 1929—32. If supply creates its own demand, there is absolutely no reason of stocks piling up in factories and a general slump setting in. It was during this depression that employers faced with lack of adequate effective demand, turned out large numbers of people and put up ‘no vacancy’ signboards being afraid of a further fall in prices. Say’s Law stood practically discredited. This gave a rude shock to Keynes’ faith in Say’s Law and led to the discovery of General Theory of Income and Employment.
3. Fallacy of Aggregation:
Keynes pointed out that the main fallacy in Say’s Law was that the principles which apply to an individual firm or industry could also apply to the economy as a whole. Keynes stressed that it was too much for Say’s Law to assume that microeconomic analysis could profitably be applied in macroeconomic considerations.
4. Misplaced Confidence in the Effectiveness of Wage Cuts:
Pigou’s formulation of Say’s Law also came under heavy fire. Keynes pointed out that a general fall in wages will not increase employment in the economy as a whole, because wages are income to a large section of the population. With the purchasing power reduced, their demand for goods and services will also fall. Employment in the economy depends on aggregate spending (effective demand) and not on wage level.
5. Wrong Assumption of Interest Elasticity of Investment:
The assumption of interest elasticity of saving and investment has also been challenged. Say’s Law presumes that all savings are automatically invested and the rate of interest brings about the necessary adjustment between savings and investment. Keynes, however, denied it on the ground that income and not the rate of interest is the equilibrating mechanism between savings and investment. Savings and investments depend upon income and are not sensitive to the changes in the rate of interest.
6. Presence of Monopoly Elements in Product and Factor Markets:
Besides, there is a conventional objection to Say’s Law as it presumed free and perfect competition in the economy. In actual practice, we see that imperfect competition in the market is the rule and perfect competition only an exception, because in modern capitalist economies there is a strong tendency towards monopoly.
7. Importance of Short-run Economics:
Say’s Law has been defended at limes, in terms of long-run equilibrium on the ground that the long-run aggregate demand tends to be sufficient to purchase all that the economy is supplying. This long-run equilibrium is brought about by the free forces of market alone. But Keynes remarked “that in the long-run we are all dead.”
8. Unrealistic Assumptions:
It would not be wrong to say that the entire thesis of Say’s Law is built upon unrealistic assumptions like flexibility of prices, wages, interest, rates, perfect competition, wide extent of the market, consumer’s sovereignty, etc. These assumptions are very difficult to realize in actual practice. Hence the difficulty and criticism of Say’s Law.
9. Money Illusion:
Say’s Law is based on ‘money illusion’ and treated money as a veil or medium of exchange. But money is a store of value and effects all economic activities like consumptions, production, exchange, distribution, saving, investment, etc. Money is not neutral as assumed by him.
10. State Intervention:
Say’s Law is based on non-intervention by State in economic activities. But Keynes recognised the regulatory role of the State. Private enterprise is guided by profit motive and may, therefore, not invest. Keynes favoured State intervention at such a time to control and regulate effective demand. He favoured mixed economy.
11. Underemployment Equilibrium:
Underemployment equilibrium is the chief contribution of Keynes. Say denied it. According to him there is equilibrium at full employment in the economy but Keynes showed that economy can be in equilibrium at less than full employment called underemployment equilibrium.