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Underconsumption What It Means How It Works Example

Underconsumption What It Means How It Works Example

Underconsumption: What It Means, How It Works, Example

What Is Underconsumption?

Underconsumption is purchasing goods and services below the available supply.

Key Takeaways

– Underconsumption deems inadequate consumer demand as the sole source of recessions, stagnation, and aggregate demand failures.

– According to the theory of underconsumption, a capitalist economy tends towards persistent depression.

– Other economic theories find that inadequate consumer demand alone does not automatically cause a recession as other factors may counteract this situation.

Understanding Underconsumption

Underconsumption is an economic theory referring to recession and stagnation. In this theory, inadequate consumer demand in relation to the production of a particular good or service results in underconsumption.

Underconsumption theories have been largely replaced by modern Keynesian economics and the theory of aggregate demand. Aggregate demand refers to the total demand for goods and services in the economy at a certain time and price level.

Underconsumption vs. Keynesian Theory

Underconsumption asserts that consumption below production is caused by insufficient purchasing power, resulting in business depression. The theory claims that workers, being paid less than what they produce, cannot afford to buy back what they produce, leading to inadequate product demand. Government intervention, specifically spending on public programs, is suggested to restore the balance between production and consumption.

Keynesian theory, however, focuses on total spending in the economy and its impact on output and inflation. Developed by John Maynard Keynes, this theory suggests increased government expenditures and lower taxes to stimulate demand and revive the global economy. Keynesian economics is considered a "demand-side" theory, focusing on short-term changes in the economy.

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While the theory of underconsumption attributes inadequate consumer demand as the sole cause of recessions, stagnation, and other aggregate demand failures, modern economic theories recognize that other factors, such as private fixed investments, government purchases, and exports, can counteract this situation.

Example of Underconsumption

During the Great Depression, the automobile industry provides an example of underconsumption. In the 1920s, increased disposable income and affordable automobiles led to higher car purchases. This surge in demand resulted in the establishment of numerous independent auto dealers and manufacturers.

However, when the stock market crashed and the effects of the Great Depression unfolded, unemployment and financial difficulties reduced Americans’ purchasing power for cars. The decreased demand for automobiles caused many independent manufacturers to go out of business.

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