Question

A) Explain how adherents to Say’s law explained the relationship between savings and investment and the behavior of wages and prices. B) What was Keynes’s criticism of Say’s law?

Answer 1

Solution-

A) Explain how adherents to Say’s law explained the relationship between savings and investment and the behavior of wages and prices.

Aggregate savings will always equal investment at full employment. People general prefer present consumption vs. future consumption, but given that savings is a function of the reward for savings, the can be induced to hold more assets in the form of savings if the interest rate is good enough. Investment was negatively related to interest rate because the productivity of given investment declined with increment increase in investment. Also an increase in savings would decrease consumption but a decrease in consumption would be matched by an increase in investment. The fluctuations of wages and prices with the change in savings and investments would guarantee a smooth short run transition. Prices would fall which would lead to increased production and would eventually raise employment.

B) What was Keynes’s criticism of Say’s law?

Keynes denied Say’s laws. He thought equilibrium of savings and investment was not such a simple matter that depending solely on the interest rate. Instead saving and investment were determined by a complex host of factors in addition to the interest rate, and there was no guarantee that the two would necessarily be equal at a level of economic activity that produced full employment. He also thought monopolies and labor unions would thwart the fluid movements of wages and prices.