Friday, February 19, 2010

Of Course Say's Law still applies

In it's simplest form, Say's Law says that "production creates its own demand." Of course, it is a simple statement of the law and this simple statement of it is easy to demolish. If I go and produce some vacuum tubes, what demand have I created? No one will want my products and so I will not get an income. In fact, I have not created demand, I have destroyed it. I have taken goods which could have made good products that people were willing to pay me for but instead I pretty much destroyed those goods. Say's Law no longer applies! Production does not create its own demand and in fact may even destroy wealth!

Well, not quite. See, this simple statement of Say's Law ignores one of the most important ideas about production: it is not all equal. It's the famous diamond-water paradox. Diamond is very plentiful and easy to extract, much like water. However, diamonds are multiple times more valuable than water. The reason is that people value diamonds more than water. Don't believe me? Then pay $1000 for a karat of water. Yeah, just what I thought. So what really matters is production of things that people value. When someone creates something that people want, people will pay for it and the person who created it will trade it for something he sees as more valuable. He profits, and some of the money he will save and some of it he will spend. Because of that profit, he will spend more than he otherwise would. So, a more accurate (but still simple!) way to state Say's Law is that "production that creates a profit creates its own demand." It is still far too simple, but this statement would do well to help explain why the only way to sustainably grow an economy is through production (and that not all production is equal).

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