According to Say’s Law, supply creates its own demand. “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” (Say 1821 cited in Snowden et al 1994, p.52). “Labour will only offer itself for employment in order to obtain income which is then used to purchase the output produced” (Snowden et al 1994, p.51). “The act of supplying one good unavoidably implies the demand for some other good” (Snowden et al 1994, p.52).
Say’s Law posits that income and purchasing power grows out of production. An agent only receives purchasing power through the production of a good and demand is therefore constrained by the amount of production in the economy (Hazlit 1959, p.33). Most importantly, it is production that opens up the demand for goods in the economy since the production of a good creates a market for other goods which are of equal value (Say 1855, p.56). An agent produces in order to bring goods to a market (i.e. to sell goods and consume an equal value of goods), it is thus not profitable for a worker to continue to produce a good which has no demand.
AD is always sufficient for full employment because production simultaneously creates an equal income and purchasing power. Moreover, there will be an automatic tendency for full employment to be established in a competitive market economy and there will be no obstacle to it in terms of deficiency of AD (Snowden et al 1994, p.52).
According to Say and the Classics, low savings do not prevent AD from achieving full employment because savings is just another form of spending as it becomes an equal amount of investment. Let’s assume an economy with 2 sectors, firms and households, then:
AD = E = C(r) + I(r) = Y
Where AD is aggregate demand, E is aggregate expenditure, C is consumption and depends negatively on the real rate of interest, I is investment and depends negatively on the real rate of interest, r is the real rate of interest and Y is aggregate output.
Households do not spend all their income because they also save so:
Y – C(r) = S(r)
Where S is savings and depends positively on the real rate of interest.
As this equation shows, in the loanable funds model, the real rate of interest adjusts to ensure that savings always equals investment. Let’s say the economy is at full employment and consumers decide to decrease consumption and increase savings. Because savings rise, the real rate of interest falls and induces an equal rise in investment. Below, in the loanable funds model, the savings curve shifts right from S to S’, the real rate of interest falls from r* to r’ and investment rises from I* to I’.