Thursday, September 1, 2022

Supply and Demand: Say's Law of Markets and Keynesian Economics (Part 2 of 2)

Click here to read the original Cautious Optimism Facebook post with comments

10 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff apologizes for the length of his second and final post on Say’s Law and supply and demand. But the slightly complicated subject of Keynesian objections to Say’s Law can’t be divided into two installments without a sizable disruption, so one post it is.

Jean-Baptiste Say and John Maynard Keynes

In Part 1 we reviewed how French classical economist Jean-Baptiste Say’s (1767-1832) “Law of Markets” proved supply always precedes demand and how demand itself must always originate first from supply.

We also established the definition of demand in economics which, going back over 200 years to James Mill, is not simply “need” or “want.”

To go back and review Say’s Law’s insights on supply and demand you can read at:


Say’s case that in market economies supply always precedes demand, and that demand grows from supply to begin with, was generally accepted by economists as correct for well over a century and still holds true today.

However Say integrated a few other tenets in his Law of Markets whose validity has not proven as durable in the economics profession.

Most controversially, Say is accused of arguing that an economy’s supply and demand are always in balance and that there are never overproductions or “gluts” of supply.

Only a few years after the publication of Say’s Treatise (1803) English economist Thomas Malthus was already challenging the “no supply glut” thesis. But Malthus was quickly outdebated by fellow Englishman David Ricardo and Say’s doctrines held up for another century.

However during the Great Depression Say’s Law met a more formidable critique from British economist John Maynard Keynes. The idea that supply gluts can’t exist has since subsequently fallen into doubt with many economists.

But first let’s start with what Say and Ricardo themselves actually described.

First, the perception that Say claimed supply gluts can never exist is largely untrue.

Say argued that an economy’s supply and demand tend to be equal but acknowledged sometimes they can temporarily fall out of equilibrium. He denied, however, that such imbalances arise from a general overproduction or overall insufficiency of demand but rather businessmen erring in their anticipation of consumer desires and making too many of certain wrong kinds of products (Treatise: Chapter 15, p. 135).

Ricardo actually spoke on the subject more succinctly than Say when he wrote:

“Men err in their production; there is no deficiency of demand."

-Letter to Thomas Malthus (1820)

Along those lines, Say also contended that a “general overproduction of everything” doesn’t cause recessions. As classical economist Steven Kates has summarized, Say’s Law states “You never, ever have a recession because of demand deficiency. A thousand other reasons, but never that.”

Instead Say advocated a more nuanced position on gluts: that recessions can occur when businessmen produce too much of one product and not enough of another. When losses expose the wrong kind of production, the process of realigning resources away from an errant production towards an undersupplied one will create unemployment, but once the misalignment is corrected growth can resume.

Finally, Say stressed such temporary imbalances in sectoral supply and demand resolve quickly via the market price system. Thus, so long as prices are allowed to adjust freely (a very important point we will come back to later), lower prices will clear inventories while signaling resource reassignment to other sectors exhibiting higher prices.

…which is just freshman level microeconomics today.

In a letter to Thomas Malthus Say asserted:

“If the quantity sent in the slightest degree exceeds the want, it is sufficient to alter the price considerably."

And in the Treatise itself Say wrote:

“When a product becomes less in demand… …All the stock on hand falls in price; the low price encourages the consumption, which soon absorbs the stock on hand.”

Now that we have cleared up Say’s more nuanced views about aggregate supply and temporary supply gluts, let’s look at Keynes.


During the Great Depression British economist John Maynard Keynes, puzzled by products and particularly labor markets clearing extremely slowly, concluded that Say’s Law—which he expressed as “supply creates its own demand”—was only correct only under special circumstances and that a more general theory was needed to explain business cycles.

Keynes proposed his own solution in his seminal book “The General Theory of Employment, Interest, and Money” (1936) where he differentiated Say’s Law from his own. 

Keynes’ conclusion? Markets failing to provide adequate demand causes depressions. Also, insufficient aggregate demand causes factories and businesses to run at partial capacity which in turn refuse to invest or hire idle workers, thus prolonging the slump.

Keynes’ proposed remedy? Both central bank cheap money and massive government deficit spending are needed to raise aggregate demand which in turn will clear the supply glut and quickly pull the economy out of its slump.

As Keynes himself wrote, if government were to borrow vast sums of money and…

“…the Treasury were to fill old bottles with banknotes [and] bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish… and leave it to private enterprise… to dig the notes up again… there need be no more unemployment and… …the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.” (General Theory, page 68)

Governments and politicians of course loved Keynes’ new theory and embraced it immediately, for it gave them academic and theoretical cover for what they love to do to this day: borrow and spend obscene amounts of money on anything they choose (usually buying votes).

Today’s Keynesian economists also consider the alleged refutation of Say’s Law to be Keynes’ greatest achievement and frequently cite the Great Depression as evidence that the free market has no built-in mechanism for clearing mass unemployment. 

Even Keynes’ critics agree that The General Theory is at its core an attack on Say’s Law. Steven Kates calls Keynes’ book “a book-length attempt to refute Say's Law.”

In fact, according to Keynes’ detractors, he necessarily *had* to disprove Say’s Law. For if he didn’t there would be no justification for central banks printing and governments spending trillions of dollars during recessions.

So after explaining the basics of Say’s Law and Keynes’ refutation, who is correct? Do markets for products and labor clear on their own? Or do entire economies get stuck with unsold goods and labor and need governments to spend more money to boost aggregate demand?


In the Economics Correspondent’s opinion Say’s Law remains valid, and both Keynes’ critiques and those employed by his followers are plagued by some errors. 

First of all, Keynes repeatedly stated Say’s Law as “supply creates its own demand” and proceeded to attack that premise. And to this day, both New Keynesian and Post Keynesian economists recite Say’s Law the same way. For example:

“Quite a few economists seemed utterly unaware that Say’s Law – the proposition that supply creates its own demand… …had been refuted three generations ago.”

-Paul Krugman: “Demand Creates its Own Supply,” New York Times (2015)

However Keynes’ version of Say’s Law is actually a misstatement, and he proceeded to criticize what is effectively a straw man: suggesting that one can produce anything and demand for that anything will magically appear.

For Say did not write that the production of apples creates a demand for apples itself. His original statement…

“A product is no sooner created than it, from that instant, affords a market for other products.”

…argued the production and sale of apples creates a demand *for other things* and in the amount that others value the apples. Note that Say specifically used the words “market for other products,” not “market for itself.”

Yet the Keynesian invention of “supply creates its own demand” rewrites Say’s Law with language that makes it sound ridiculous. And to this day, less-informed Keynesians (like Paul Krugman’s readers) believe that simply repeating a semi-absurd-sounding canon automatically refutes Say’s Law with no further discussion needed.


Then there’s the central argument regarding macroeconomic supply gluts. 

Keynesians contend that the Great Depression, a slump where the job market required an unbelievable sixteen years to clear to full employment, proved that a market economy cannot clear supply gluts on its own without government spending to boost aggregate demand. In their eyes, *the* preeminent exhibit refuting Say’s Law is that Great Depression, a slump where massive inventories did in fact pile up, and labor took painfully long to clear.

But recall that Say argued it wasn’t overall supply gluts that cause recessions but rather overproduction in some sectors and underproduction in others. Furthermore Say asserted those sectors will realign and adjust quickly *when prices are allowed to adjust freely.* A market where prices aren’t allowed to adjust freely is an unfree market where governments interfere (i.e. price controls).

So were prices allowed to adjust during the Great Depression?

Only someone woefully uniformed on the Great Depression could make such an assertion. The 1930’s were the greatest experiment in government price controls—artificially forcing prices higher—in American history. The list of offenses is so great that the Correspondent only has room to discuss three of them here:

1) First there was wages.

One of Herbert Hoover’s first acts after the 1929 stock market crash was to pressure businessmen not to reduce nominal wages even as deflation lowered prices 30% due to bank failures and deflation. The result, in real terms, was a 40%+ pay raise for those workers lucky enough to still have a job.

In the middle of a major depression, paying 40%+ higher real wages left employers with only one real option: lay off workers. It’s no coincidence the unemployment rate was already 23.6% by 1932.

After Hoover was gone and businesses began lowering wages Franklin Roosevelt inserted minimum wage clauses that encroached even on factory worker salaries in his 1933 National Industrial Recovery Act. He then armed labor unions with new government powers via the 1935 Wagner Act.

Unsurprisingly, with wages pushed up above the market-clearing level the result was persistent unemployment—over 10% for more than a decade and above 15% for seven years—or what Keynesians would call a market “supply glut” of labor which they then argue proves Say’s Law is invalid.

The Economics Correspondent has written in greater detail on Hoover and FDR wage floor policy at:

2) In agriculture, the Hoover administration spent the equivalent of hundreds of billions of dollars in today’s money to purchase crops and lock them away in government warehouses to force up the price of food.

Again unsurprisingly, the artificial price floor resulted in huge stockpiles of unsold produce and livestock—another “supply glut”—which Keynesians also blame on a failure of Say’s Law.

The Correspondent has written about Hoover and FDR agricultural price floor policy at:

3) Lastly, in terms of general products and services, FDR’s National Industrial Recovery Act (NIRA) forced business leaders to collude and artificially raise prices which, yet again, pushed them above the market clearing level and created supply gluts of unsold goods. The result was slowing of production, layoff of unneeded workers, and the very idling of factory capacity that Keynes argued was a free market phenomenon.

The NIRA went further by establishing over 400 legal codes that were forced on more than 2 million businesses, imposed artificially high government-fixed prices for tens of thousands of products, and criminalized any reduction of prices below state-mandated levels.

The list of distortive price-fixing and business practice codes during the 1930’s is also too enormous to fully provide here, but some of the most outrageous examples of NIRA cases can be found in the addendum section below. 

Either way it’s clear the U.S. economy under the Hoover and Roosevelt administrations was an entirely different world from the market economy Jean-Baptiste Say described in 1803.

So whenever you hear Keynesian economists argue “the free market” produced a supply glut during the Great Depression, remember that a key condition of Say’s Law is that prices and wages must be allowed to fall in response to a temporary sectoral insufficiency of demand, not politicians forcing prices up throughout the economy and artificially creating supply gluts as they did in 1930's, and which Keynesians then call a failure of the free market to provide adequate demand.

Or as Austrian economist Henry Hazlitt summarized in “The Failure of the New Economics,” his line-by-line refutation of Keynes’ General Theory:

“Keynes did not succeed in refuting Say's Law of Markets. His attempted refutation consisted merely in ignoring the qualifications that the classical economists themselves insisted on as an integral part of the doctrine.”
Addendum on the National Industrial Recovery Act:

Three egregious examples of FDR’s National Industrial Recovery Act (NIRA) pricing code enforcements:

1) In one of the famous NIRA cases of the 1930’s:

“A New Jersey tailor named Jack Magid was arrested and sent to jail for the ‘crime’ of pressing a suit of clothes for 35 cents rather than the NRA-inspired ‘Tailor's Code’ of 40 cents.” (Lawrence Reed, 1998)


2) “In Sidney Hillman’s garment industry the code authority employed enforcement police. They roamed through the garment district like storm troopers. They could enter a man’s factory, send him out, line up his employees, subject them to minute interrogation, take over his books on the instant… [they] went through the district at night, battering down doors with axes looking for men who were committing the crime of sewing together a pair of pants at night.” (John T. Flynn, 1944)

3) And in another famous NIRA enforcement challenge that went to the Supreme Court:

Schechter Poultry Corp. vs United States, or the so-called “sick chicken” case—government prosecutors indicted four Jewish chicken slaughterers on 60 counts of violating NIRA codes for mispricing poultry. In an exchange that the press rightfully mocked as ridiculous, government prosecutors argued to the court that:

“The poultry purchaser must come into the market and take all the chickens in a coop. He cannot go and select the choice chickens out of the coop.”

“If he does select the choice chickens out of the coop, as was the custom at one time, it brings down the prices in the sale of the lower-grade poultry, and the sales of the lower-grade poultry in turn bring down the prices of the higher grades.”


“His customer is not permitted to select the ones he wants. He must put his hand in the coop when he buys from the slaughterhouse and take the first chicken that comes to hand.”

The official “sick chicken case” transcript in its full absurdity is available at:

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.