Jean Baptiste Say was on early 19th century French economist who wrote the book political economy and propounded law of market with famous proposition “supply creates its own demand.” It is pivot of classical theory. According to Say- “It is production which creates markets for goods. A product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. Nothing is more favourable to the demand for one product, than the supply of another”.
Thus, every additional supply creates an additional demand. There can be no generally over production. It is original form. This is applicable for a barter economy where commodities are exchanged for each other. Every commodity brought to the market for fulfill the need of other commodity. In say’s opinion, work being unpleasant no-body will produce a product unless he wants to exchange it for other products which he desire. Thus, supply of any product is demand for other products. Therefore, there will be no any over production because supply of products will not exceed aggregate demand.
The existence of money does not alter the basic law. Neo-classical economists consider that say’s law has wider application in monetary economy. In a free market economy, the money cost of the goods produced by the firm are actual paid out as incomes to households for their factor services supplied. This means that supply of a product generates the income to the households in the form of wages, interest, rent and profit to demand other goods produced. According to Professor Hansen “Say’s law, in a very broad way is a description of a free exchange economy. So conceived, it illuminates the truth that the main source of demand is the flow of factor income generated from the process of production itself.”
Thus factor owner earn income in the form of rent, wages, interest and profit by production process. This in turn, causes demand for the goods produced. In this way supply creates its own demand. But this concept is based on the assumption that all income earned by factor owner is spent in buying commodities produced by them. If all income is not spent or saved that must be invested saving. According to this theory, if there is any difference between saving and investment the quantity is equalized through the mechanism of the rate of interest. According to classical thought interest is reward for saving. The higher the rate of interest, the higher will be the saving and vice-versa. But on the other hand the lower the rate of interest, higher the investment demand for capital, and vice-versa. Thus, rate of interest maintain equality between saving and investment at any period of time, the rate of interest will decline, and saving will fall and investment will rise till saving will equal to investment and employment will be full at that time.
Above mechanism of equality between saving and investment can be explained by the help of following figure:
In above figure, SS is saving and I1I1 is investment curve. When rate of interest is or1 both saving and investment are equal to OK. Suppose there is an increase in investment, then the investment curve shifts to right hand side as I2I2 as shown in figure. At or1 rate of interest investment demand is OK3 which is greater than saving OK. According to classicals, the saving curve SS remains at its original level and to maintain the equality between saving and investment, rate of interest will increase. Rate of interest increases to or2 and equilibrium shifts E1 to E2 and saving and investment are equal at OK2.