[jmlicari]

Before I got my teaching position in Far Rockaway, NY, I was making ends meet by working as a freelancer at a textbook publisher – Worth Publishers. One of the textbooks I was working on was called Society and Technological Change by Rudi Volti. My job was to reformat the book from PDF to Word in order for the author to edit the new edition. Occasionally I would skim through it and see how much BS this person was writing. This excerpt really got me upset:

In other cases, lower prices may not result in significantly higher levels of demand because people will buy only so much of a particular product irrespective of its price (in the jargon of economists such a product is “price inelastic”). Even so, since consumers pay a lower price for this product, they have more money left over to spend on other things. This increases the effective demand for other products and enhances the employment prospects in the industries that make them. To be sure, many economists believe that there may be times when aggregate demand will be insufficient because consumers prefer to save the extra money rather than spend iton new purchases. This phenomenon of “underconsumption” may in fact have been the underlying cause of the Great Depression of the 1930s. Under such circumstances, governments may have to stimulate demand by increasing their own expenditures, even if this means running budgetary deficits.9

9. For a review of how economists have viewed the relationship between employment and technological change, see Gregory R. Woirol, The Technological Unemployment and Structural Unemployment Debates (Westport, CT: Greenwood Press, 1996).

I thought you all would love to take your stabs at this, especially Dr. Woods.

[gutzmank]

It’s simply classic post-1929 Keynesianism. Nothing special.

[negligible91]

J.B. Say, a 19th century economist, exposed the fallaciousness of the underconsumptionist philosophy in an economic law that came to be known as Say’s law. Basically, it states that the demand for a good is made up of the production of other goods. This economic law can be represented fairly easy by a barter economy. If there are only two goods, apples and oranges, and someone wants to buy an orange, they have to exchange an apple for the orange. They would not be able to buy the orange without first producing an apple. So in a larger economy, the production of a larger amount of goods will make up the demand for the orange. And in a money economy, this is no different, because money is only a medium of exchange, that eases the process of exchange (producers simply sell the products they produce for money, and then exchange the money for other products; the only difference is that there’s an intermediate step). Because of this, there cannot be a general overproduction of goods (the flip side of underconsumption). There can only be an overproduction of goods in one sector and an underproduction in another.

Now, as to your particular example, all additional saving brought on by lower prices means that consumers value consumption in the future more than consumption in the present. If consumers decide to save more, additional “stimulation” of aggregate demand will just result in creating and then prolonging a bubble of particular areas of production that consumers do not desire.

Also note that from 1921-1929, the money supply was increased in attempt to maintain price stability. Austrian business cycle theory predicts the inevitable bust from this unsustainable boom. ABCT also happens to be consistent with Say’s law, unlike the Keynesian theory of underconsumption that Volti explained.

Hope this reply is helpful!

[negligible91]

Oh, forgot to mention, increased saving will lower interest rates, acting as a market signal to producers that consumers desire increased consumption in the future more than increased consumption in the present. This will allow producers to increase capital (and therefore, future consumer goods) rather than increasing the supply of current consumer goods. An increase in the money supply by the central bank distorts this signal.

[woods]

My family and I have been in the process of moving, a little at a time, for the past couple weeks, so I’m afraid life has been rather hectic around here. But better late than never.

What I recommend you do is re-post this question to our new discussion forum on Austrian economics and invite Prof. Herbener’s response. Rothbard discusses “underconsumptionism” a bit in the opening section of America’s Great Depression. There are many avenues from which to attack it, one of them being Bharat’s argument, another being the empirical case: if “underconsumption” is the cause, why did consumer-goods industries do considerably better in the crash than producer-goods industries? In my lecture on this I give some of the statistics.

[jmherbener]

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.

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