Jean-Baptiste Say

One notable contribution was the division of resources into the four primary categories of labor, capital, land, and entrepreneurship. In particular, he stressed the importance of entrepreneurship as a factor of production. Another contribution was the observation that value (or the price of a good) depends on both the cost of production and the satisfaction (or utility) generated from consumption. Say also identified some of the basic notions of money that are standard textbook topics, include the characteristics of money, double coincidence of wants, and the natural evolution of commodity money.

Of course, at the top of the list of contributions is his theory of markets--Say's law. Actually, Say was only one of several classical economists who put forth the basic argument that "supply creates its own demand." Whether or not he was the first is not readily known, but as a major proponent, it bears his name.

A Theory of Markets

A essential feature of Say's theory of markets was the interdependence of market activity, that is, the demand for one good is dependent on the production of another good. The income generated from the production of one good, such as OmniMotors XL GT Sports Coupes, generates the income that is used by consumers to purchase other goods, such as Hot Momma Fudge Bananarama Ice Cream Sundaes or Wacky Willy Stuffed Amigos.

Say's theory of markets directed attention to the supply or production side of the economy (compared with later Keynesian economics that focused on the demand or consumption side). Say contended that macroeconomic activity began with production--without production there was no consumption. Moreover, his famous law of markets indicated that aggregate production generates sufficient aggregate demand to purchase all available output.

However, Say's law of markets DID NOT mean that all markets would be in balance at all times. Some markets could have surpluses and others could have shortages. In aggregate, though, the surpluses and shortages balanced out giving an overall balance of aggregate production and aggregate demand.

Moreover, Say's law of markets DID NOT indicate that an economic downturn (that is, business-cycle contraction) was impossible. His law merely placed the cause of any downturn on the supply side of the economy, not the demand side. According to Say, a recession was not due to the lack of demand and the overproduction of goods (a primary contention of Keynesian economics). Instead, such problems were attributable to money.

The Circular Flow

Circular Flow

While debate continues over the validity of these theories, as well as the relative importance of aggregate supply (stressed by new classical economists) versus aggregate demand (emphasized by Keynesian economists), Say's law of markets is revealed in the less controversial circular flow model.

The exhibit to the right presents the basic circular flow model of economic activity. To the far right of the exhibit is the business sector and to the far left is the household sector. At the top of the exhibit are the product markets and at the bottom of the exhibit are the resource markets. The business sector buys the services of resources through the resource markets from the household sector, which it uses to produce the output (gross domestic product) that is sold to household sector through the product markets.

The income (national income) that the household sector uses to purchase production is generated by factor payments to resource owners by the business sector. If the business sector produces no output, then the household sector has no income to spend on consumption. This relation captures the essence of Say's law. More production by the business sector means more factor payments to the household sector and more income that can be spent on consumption.

A Keynesian Critique