What is Underconsumption?

Underconsumption is the purchase of goods and services at levels that fall below the available supply.

Key Takeaways

  • Underconsumption is an economic theory in which inadequate consumer demand results in business depression.
  • Underconsumption is different from Keynesian theory. The former identifies inadequate consumer demand as the root cause of recession while the latter also considers other causative factors, including private fixed investments in factories, machines and housing.

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 date back hundreds of years and have been largely replaced by modern Keynesian economics and the theory of aggregate demand, which is the total demand for goods and services in the economy at a particular time and price level.

Differences Between Underconsumption and Keynesian Theory

Underconsumption asserts that consumption of less than is produced is caused by insufficient purchasing power and results in business depression. Furthermore, the theory of underconsumption claims that because workers are paid a wage lower than they produce, they cannot buy back what they produce, therefore resulting in an inadequate demand for the product. This can be rectified by government intervention, specifically spending on public programs, to restore the balance between production and consumption.

Keynesian Theory is a theory of total spending in the economy and its effects on output and inflation, and was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the depression. Keynesian economics is considered a "demand-side" theory that focuses on changes in the economy over the short run.

The theory of underconsumption deems inadequate consumer demand to be the only source of recessions, stagnation, and other aggregate demand failures, and therefore a capitalist economy tends toward a state of persistent depression because of this. In contrast, modern economic theories find that inadequate consumer demand does not automatically cause a recession because other factors, including private fixed investments in factories, machines and housing, and government purchases and exports may counteract this situation.

Example of Underconsumption

An example of underconsumption is the automobile industry during the Great Depression. During the 1920s, increases in disposable income and the new affordability of automobiles resulted in more people purchasing cars. Increased demand led to the creation of a large number of independent auto dealers and manufacturers. When the stock market crashed and the effects of the Great Depression took hold, many Americans became unemployed and encountered financial troubles, resulting in less purchasing power for cars in relation to the supply. Due to the plummeting demand for automobiles, many independent manufacturers were not able to stay in business.