Demand and Supply is no Chicken or Egg Problem

Written by: Russell Lamberti

This article is in response to: Which Came First: The Chicken or The Egg?

The author has some vaguely correct instincts on this topic, but makes some errors that seem to betray a very incomplete understanding.

Most problematic paragraph is third from last. Let’s go through it:

“Say was a classical economist who posited in the early 1800s that production must precede demand; “a product is no sooner created than it…affords a market for other products to the full extent of its own value”. What Say did not posit is that producing something will automatically cause that particular thing to be sold.”

Correct so far…

“He merely said that, on a macroeconomic level, you first have to produce in order to attain money (the fruit of your labour) so that you can demand other things.

He actually meant that this is true at an individual level, and hence necessarily at the macro level, the macro merely being an aggregation of many individual cases. Also, money per se is inconsequential to Say’s Law.

“A little over a hundred years later, however, Keynes came along during The Great Depression and posited that demand precedes supply over the short term and that we cannot depend on supply preceding demand because slumps in supply during recessions cannot be explained by Say’s thinking and would kill us all in the long run; “in the long run we are all dead”.

Keynes did attack Say (roughly) as you suggest, but his “in the long run we’re all dead” quip was in response to his critics claiming (correctly) that his policies were short-termist and would eventually fail in the long run. Keynes, rather than refute them, implicitly admitted they were correct by saying that we wouldn’t be around to deal with the mess. It wasn’t, to my knowledge, a comment on the long run failure of “depending on supply”, but rather a stunning admission of the intellectual shallowness of his theory and, quite frankly, of Keynes himself.

“Keynes did bastardise Say’s position a bit though by stating in The General Theory of Employment, Interest, and Money that supply creates demand according to Say.”

He misrepresented Say entirely and refuted a straw man.

“Say merely said that supply precedes demand in general. Supply only creates demand for the specific product supplied if the supplier responds to a specific demand for it or successfully markets it.”

Say did not say “supply precedes demand in general”, but that producing things valued in the marketplace is the source of the producer’s purchasing power in the marketplace. Or put another way, we buy things with things. Even more generalised: we can only procure value with value. Supply doesn’t create demand “for the specific product supplied”. By saying this, you’re interpreting Say’s Law to mean that production of something is the source of demand for itself BY OTHERS. No. Production is the source of purchasing power FOR THE PRODUCER, TO THE EXTENT THIS PRODUCTION IS VALUED IN THE MARKETPLACE. Producing mud pies is “supply”, but it confers no purchasing power to the producer because no one values it in the marketplace. This last point is precisely why Say’s Law is NOT a labour theory of value. Say’s Law effectively says that production IS NECESSARY to create purchasing power, but NOT SUFFICIENT. Labour theory of value says it IS SUFFICIENT. Keynes says it is NOT NECESSARY!

“Keynes’ misstatement of Say’s Law has led to some misunderstanding of Say’s position when applied on a microeconomic level, but Keynes’ view that economic recessions are caused by slumps in aggregate demand and that boosting the aforementioned through quantitative easing has indeed been proven to have validity.”

It has led to a woeful misunderstanding of Say’s Law and set the economics profession back about 200 years. And no, Keynesianism has not been proven to have validity. Keynes’ view is theoretically disproven by the logical unassailability of Say’s Law. Since Keynesian theory does not logically invalidate Say’s Law (only a bogus straw man), seeming empirical evidence validating the Keynesian view must be spurious. Indeed, the entire Keynesian house of cards is predicated on empirical spuriosity. Just because demand falls during economic recessions does not validate Keynes. Say’s Law ALSO predicts that the recession will manifest as slumping demand. But Say’s Law, and particularly David Ricardo’s restatement of it, explains this slump as the result of misdirected production. That is, a shift in production to goods and services less valued in the marketplace.

This concept was explained in deeper and more sophisticated terms by Mises and Hayek in their business cycle theories. Once demand slumps, the solution is correcting the MIX of what is produced to goods and services that are more highly valued in the marketplace. The means to correct the production mix is to allow producers and entrepreneurs to discover the best mix as quickly as possible using market signals. This means free markets, no price controls, and removal of rigidities like regulations. It also means encouraging savings, so that capital wasted on misdirected lines of production can be replaced and allocated to the most valued lines of production.

How the mix of production becomes misdirected is another topic entirely, but is overwhelmingly the result of prior state meddling which distorts key market signals. Keynes on the other hand explains falling demand in the recession as the result of waning “animal spirits”, presumably his term for some unexplained and arbitrary “loss of confidence”. This mysterious loss of demand must be restimulated by the state acting (somehow, but never explained by Keynes) as an all-knowing, god-like force, acting in a capacity that’s external to the system, by borrowing and printing money to spend and hence “raising aggregate demand.” The Say’s Law remedy is therefore to help producers (really all suppliers, including suppliers of labour) reallocate production to best suit the needs of the market. The Keynesian remedy is to perpetuate misdirected supply by consuming savings and capital to keep buying up the misdirected supply. Keynesianism therefore can only ‘stimulate’ an economy out of recession by destroying wealth and perpetuating the very mistakes that caused the recession (ie healthy correction) in the first place, leading to greater need for eventual recession (correction).

There is thus no chicken-egg dilemma in demand and supply. Production in the marketplace is a speculative activity in which producers attempt to produce goods and services other producers need, with the expectation of trading their produce with them. What is most wanted in the marketplace is signalled by relative exchange ratios in a barter economy, or relative money prices in a monetary economy.

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