Say’s Law

Abstract

Say’s Law states that aggregate supply necessarily creates an equal amount of aggregate demand. It is the cornerstone of supply-side economics. Say’s Law is an economic idea you should forget because it implies a view of money that is untenable. Every textbook tells you that money acts as a medium of exchange and as a store of value, but Say’s Law reduces money to the former. It implies that money income must be spent. Aggregate production consists of consumption goods and investment goods. Say’s Law would hold if the income not spent on consumption goods must be spent on investment goods, in which case, produced income (supply) would always equal spent income (demand). Hence Say’s Law is the flip side of the loanable funds doctrine, which also implies that total money income must be spent. The income not spent on consumption goods is saved, and since it is irrational to forfeit interest income according to the loanable funds doctrine, savings must be spent on interest-bearing loanable funds, which are emitted by firms in order to finance investment spending. When the economy is in a situation where the desire to save is high and the desire to invest is low—probably due to high interest rates—aggregate demand for consumption and investment goods can be lower than the output of these goods. But at the same time, there would be an excess demand for loanable funds, which would depress the interest rate until equilibria in both the goods and the loanable funds markets are established.