Question

4. Briefly describe the two conclusions that can be drawn from an overview of Say's Law with its emphasis on macroeconomic supply and Keynes' Law with its emphasis on macroeconomic demand.

Answer 1

The eminent French economist J.B say propounded the Law of market based on supply side of the economy which is popularly known as Say’ Law of Market. According to his view, ‘Supply creates its own demand’. The reason is that every producer produces goods in order to get other goods in exchange. When a producer produces goods, he pays factor income in the form of rent, wage interest and profit. Thus when a goods are produced there is a corresponding flow of income which is sufficient to purchase the goods. People use this income to buy the goods produced. Thus a demand is simultaneously created with the supply of goods. Thus the chance of overproduction and the resulting unemployment is ruled out.

But aggregate demand can be mismatched in the event of saving in the economy. J.B Say explains that if the people save, the aggregate demand falls short of aggregate supply to the extent of saving in the economy. But in the event of saving, also aggregate demand is fully matched with aggregate supply. People convert their saving into investment. If there is inequality between saving and investment, it will be automatically corrected through the fluctuations in the rate of interest. Both investment and saving depends upon the rate of interest. Saving is an increasing function of the rate of interest and investment is a decreasing function of the rate of interest. If the saving is greater than investment the fall in rate of interest increase the investment till both are equalized. If the investment is greater than the saving the increase in rate of interest reduce the invest till the equality of the both. If unemployment prevails in the economy, it implies that the saving in the economy is greater than the investment. The aggregate demand will be less than the aggregate supply. This will result in reduction of the rate of interest. The fall in rate of interest creates sufficient investment to eliminate the deficiency in aggregate demand. Thus according to J.B Say supply creates its own demand and there is no chance of overproduction and involuntary unemployment.

While J.B Say emphasize on the supply side of the economy to maintain fullemployment, Keynes emphasis on the demand side. According to Keynes the assumption that supply creates its own demand is unrealistic and invalid. People do not spend all of their entire income. They save a part of it. Thus aggregate demand falls short of aggregate supply. The people who invest is influenced by the level of profit rather than the rate of interest. The economy will be unable to generate sufficient level of investment to eliminate unemployment if the expected rate of return is lower even if the rate of interest is low. Thus the deficiency in aggregate demand causes overproduction and unemployment in an economy. The economy can maintain fullemployment by maintaining aggregate demand to a level sufficient to create fullemployment. The consumption is regulated by the marginal propensity to consume which is less than 1 but greater than 0. Thus as income increase the aggregate consumption falls short of aggregate income. This cause accumulation of saving. If the expected return on investment is low the aggregate investment cannot keep parity with aggregate saving. Thus the result will be overproduction and unemployment. Thus Keynes stress on the management of aggregate demand to maintain fullemployment through fiscal measures.