Reply To: Refute This!


Thomas Malthus advanced underconsumption against Say’s law. Malthus accepted that production (supply) of all goods generates income sufficient to buy all the goods produced, but he denied that people must spend all of their income. Effective demand depends on both the income and the will to spend it. Keynes would later incorporate Mathlus’s concept of “effective demand” into his own system and Keynesians, like Paul Krugman, would use it to claim that increasing income inequality leads to inadequate aggregate demand since the middle class must spend their income just to sustain themselves but the rich have discretion. For example, if entrepreneurs have produced under the expectation that everyone is spending 95% of his income and then some people grow wealthier and spend only 75% of their income, overproduction will result. Malthus and Keynes, at least in some places, admitted that savings represents potential demand through investment. But, the uncertainty involved in the process of S-I producing future consumer goods could not guarantee enough effective demand to buy all the goods produced. Finally, even if the process of S-I operates properly, there could be hoarding which would bring aggregate demand up short of buying all the goods produced. In any case, the result is a cut back of production. Underconsumption is an explanation for depression.

Underconsumption cannot cause a depression on the unhampered market economy. Entrepreneurial production decisions are guided by profit and loss. Hoarding increases the purchasing power of money. The lower prices allow all the goods produced to be purchased. As prices of consumer goods fall, entrepreneurs lower their demands for producer goods and their prices fall. Profit is maintained and production continues. Shifts from consumption to saving-investing raise the prices of capital goods relative to consumer goods leading entrepreneurs to shift production accordingly. The built up capital structure renders more consumer goods in the future, which satisfies the shift from consumption to saving-investing in the present.

A depression is the correction of the malinvestment and overconsumption of a previous boom. Credit expansion through monetary inflation suppresses interest rates leading to an unsustainable build up of the capital structure and overconsumption. The correction of the bust appears to be underconsumption as people shift toward saving-investing. The over-expanded areas of consumer goods production, e.g., housing, autos, etc. suffer decline.