Doubting Say's Law
Say's Law works in a barter economy where there is no money. Fish trade directly for bananas, bananas trade directly for coconuts, and coconuts trade directly for fish. Say and his allies were convinced that the introduction of money would not change anything other than to make the analysis more difficult to follow. To keep things simple, they ignored money. However, many economists today think that the introduction of money not only complicates the model but also invalidates the original conclusion of Say's Law, that there can be no oversupply of goods.
We can see what happens with the introduction of money in the table below. As before, columns must sum to zero, but now Crusoe catches fish either to consume himself, to trade for bananas or coconuts, or to trade for money. As a result, a "general glut" or an oversupply of goods will occur when there is an overdemand for money. The table illustrates this possibility.
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Fish |
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Coconuts |
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Bananas |
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Money |
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Summation |
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The most interesting part of a table such as this one is not the light it casts on the "general-glut" controversy, but the way it illustrates the connections among markets. The second table is more useful than the first one for this because entries can more easily be discussed in terms of values--prices multiplied by quantities. Thus if the monetary unit is a dollar, the +5 in Crusoe's column represents $5.00 worth of fish he plans to supply to the market. As a result one can more easily discuss the central assumption that makes the columns sum to zero, that expected or planned sources of funds must have expected or planned uses. Since the columns sum to zero, any change in one market must affect another market. If Crusoe decides that he wants to spend more on bananas, he must either expect to spend less on coconuts, reduce cash balances, or sell more fish.
The interaction among markets involved in the second table is in some ways similar to the way the showers in a large shower room interact. Suppose ten people have all adjusted their showers so that the water temperature and pressure are just right. When an eleventh person comes in and turns on another shower, all the other people are affected and they may find that they do not like the changed temperature or pressure. They will begin to turn valves in hopes of adjusting back to their previous condition. Instead of showers, we have markets. Changes in any one market affect supply and demand curves in other markets, causing prices and quantities in these markets to readjust.
The interactions among markets are crucial and central in macroeconomics. Although the true meaning of Say's Law may be a matter of dispute, the interaction of markets that these tables illustrate is not in dispute. Rather it is at the center of many current controversies among macroeconomists. If a system of many interdependent markets is in disequilibrium, will it return to an equilibrium? If it does return to an equilibrium, what factors determine the speed of adjustment? Can there be more than one equilibrium in such systems? Does it matter for the adjustment process if markets are not competitive? Can an equilibrium for the system exist if some markets do not clear, that is, can some markets have surpluses or shortages when the system as a whole is in equilibrium? Finally, what sorts of forces cause disequilibrium in the first place?
We are now ready to understand why macroeconomics aggregates the way it does.
Copyright Robert Schenk