What happens in an economy when supply outstrips demand

I have read during this economic crisis, in the US, that the labor force was cut by 10% (when counting both hours worked and number of workers) but productivity was only cut 3%.

So now our wage earning labor force is only 90% what it was, but productivity is 97% of what it was. So there is supply but no demand.

During the industrial revolution it wasn’t uncommon for factories to remove 3/4 of their workforces due to the higher productivity brought about by the devices being installed.

So an issue with higher productivity is there is a window where the labor pool is flooded with idle workers and where supply outstrips demand afterwards. If you had 100% of wage earners buying 100% of goods/services, you can’t have 90% of wage earners buying 97% of the goods and services. Especially when you consider that economic insecurity results in less spending and more savings on top of that issue. Of course that neglects imports/exports.

Plus with a large labor pool of idle workers, wages & benefits aren’t going to go up. Immediately after the industrial revolution you’d assume there were people lined up to replace the old factory workers. So they couldn’t demand better treatment, wages or benefits because of how expendable they were.

I really wish I’d taken economics in college. And I’m too lazy to read books on it now.

I’m not sure if this is a question or debate. I assume a question.

What happens in the period after supply outstrips demand like the industrial revolution, the great depression or the current recession? How do economies eventually find jobs for the people who were let go, make workers feel more secure in their jobs (so they can demand better wages and feel more comfortable spending) and end up restimulating demand?

Do corporate profits go up until they reinvest them in new job creation? Is there a general response to these situations or does it vary?

Prices go down. Deflation happens. Interest rates go down to almost nothing, but borrowing money is harder than before. Generally speaking, it is a Very Bad Thing, depending of course on the particular financial circumstances surrounding it. Eventually the supply side will cut back production (or wages) until there’s a balance with demand, and at the end of the day everyone is a little poorer in real terms. It’s hard to convince investors to spend capital in times like this. Growth in capital is very hard to find. Stock prices go down, sometimes WAY down, even overshooting the expected “bottom” like a rubber band stretched to far, only to come back up (but not quite as high as before). That kind of back-and-forth rubber-band stock price fluctuation makes investors much more nervous, and they start flooding toward “safe” investments like traditional savings accounts, government bonds, low-yield corporate bonds, precious metals, and mayonnaise jars buried in the back yard. Someone who buried money in their back yard for the past 4 years was substantially ahead of someone diversified in the stock market. Why would anyone risk money making investments in such an atmosphere? This makes it very hard for business to expand or upgrade or improve infrastructure. Less taxes are collected, meaning government services have to be cut.

All in all, very drastic changes in the supply or demand side are bad for the economy. People like stability, and hate volatility, even though there was a window of a few months in which buying stocks would have returned 50% or more over less than a year. Recently the economy has started to “stabilize”, which means stock prices and employment rates and manufacturing has more-or-less stopped free-falling into an abyss, but does not necessarily mean things are getting “better”. The stability itself is usually what starts the healing process, though. Once companies can actually make predictions about their business more accurately than a magic 8-ball could, they will start hiring and making long term plans again. Employment rates will rise, stock prices will stabilize, investors will start investing again, people will buy property, etc. etc. Hopefully.

There are a lot factors to consider, but productivity doesn’t relate directly to value. People will stop wasting money on luxuries and frivolities in hard economic times, but they don’t stop eating. Profits may go down for the suppliers, but that doesn’t lead to automatic cuts in production, especially in competibe industries. We also have programs to provide people with money when they don’t have any. Long term, in theory, that borrowed money should reflect across the board, but economic crisis are more dynamic than simple supply and demand can predict answers for. The previous post talked about predictability and stability that often have much more influence on productivity than short term fluctuations in demand. I’ll add the hopefully as well.

New jobs result from innovation, demand follows. Innovation results from being human. You don’t need an economics course to do that math, only patience to wait.

Job training or retraining is a major way that replaced workers are put back to work. In the “good old days” that was pretty much the responsibility of the worker to pay for training or find someone willing to train him. In the modern age, retraining is often paid for by the government as part of unemployment or even by the firing company as part of the severance package.

For example, a friend lost his job when he closed his business. He’s now taking six weeks to learn how to drive trucks. This is at his own expense.

As another example, I was recently contacted by someone who had been a project manager in a construction company when the economy went south. As part of his unemployment, the state is paying for him to get a two-year accounting degree. Washington state does this most often when a worker was in a field deemed in declining demand, with the retaining available in fields deemed to be in increasing demand.

One of the reasons that companies continue to produce product after demand has fallen off, is that the warehoused inventory can be used for borrowing power. Inventory is like money in the bank, but only up to a point.

New jobs and demand in India and China. Have patience while your American wages fall the levels offered by those countries.

As for the OP, you might be interested to read about the Long Depression that occurred at the tail end of the Industrial Revolution. It only lasted twenty years or so.

But there aren’t jobs to replace the lost ones. The economy lost the equivalent of about 11-14 million jobs when you factor in hours cut and lack of job growth to keep up with population.

Its not like there are 11-14 million new jobs in different fields just waiting for people to get trained to do them. There is a surplus of labor and a shortage of work for the labor to do.

Eventually people who used to work in agriculture found jobs in factories. When those upgraded people in factories found jobs in the service sector. But in each situation tons of employed people were kicked off the rolls, productivity skyrocketed while demand either stagnated or went down (because of fewer wage earning consumers).

One problem is wage inertia. There doesn’t seem to be a reasonable way to decrease wages comparably to supply/demand short of laying people off, so that’s what we do.

If there is say 5% less work to do, a better way would be to decrease everyone from 40 hours to 38 hours and cut their salaries a bit. Instead, we lay off 5% and keep paying the rest their current, now inflated, salaries.

When supply is greater than demand, prices drop, increasing demand.

Ah yes. A real question of our time. It’s already been basically answered, but I might as well throw my own explanation into the mix. Can’t hurt to have the same thing explained by different people.

Let’s start with this:

This is what we would generally expect to happen. It’s basically the Adam Smith answer: Prices drop, demand increases, and markets reach their new equilibrium. Unfortunately, it doesn’t work out quite so painlessly.

The problem is that wages drop more slowly than other prices.

Human beings are loss adverse, and they strongly resist any decreases in their wages even in economically serious situations. The Great Depression was a particularly striking example of this. This was a time of insufficient aggregate demand, pushing the prices of nearly everything downward. And yes, the masses of people who had lost their jobs would have accepted much lower wages. But the funny thing was that the people who had kept their jobs did not suffer the same decrease in their wages. Their nominal wages were relatively stable. So in effect, the purchasing power of the people who still had jobs was becoming stronger. Their wages were relatively steady, but the prices at the grocery store were dropping like a rock. They were, in real terms, getting richer even though the nominal value on their paycheck wasn’t really changing. Real wages increased during the Depression

Now look at it from the employers’ situation. They have a trained workforce that they don’t want to replace overnight, so they’re not going to fire the entire staff and hire unknowns at less cost. So they’re paying about the same nominal rate in wages. But as for the goods they’re selling? The price of those goods are dropping, because of insufficient aggregate demand. Same wages, but a lower return from sales? Big trouble for the business. And big troubles means more people want to hoard money instead of spend it, which means another hit to aggregate demand. It can become a vicious cycle.

One trick to beating it is to fight the deflation. The entire reason that there’s insufficient aggregate demand is because we have a currency that people can hoard instead of purchasing things. Money stops moving around because people want to save, but this has the perverse effect of undermining the economy in the process. This is famous paradox of thrift. The solution is to get money moving again. During the Depression, the single most effective policy for recovery was dropping the gold peg.

There are a few problems with this in the current situation. First, the new jobs often pay less than the old jobs, which continues to reduce demand. Second, as you mention, people cannot switch jobs without fairly extensive training. For instance, the health care industry still seems to be in good shape - but it takes time to train to be a nurse, and in California, at least, there are long waiting lists for nursing programs in community colleges. Third, the increase in unemployment means the states have less money, and so they have less money to fund these useful programs. (Most have to balance their budget every year.) The Feds can help, but that increases the deficit, and I’m sure you’ve heard the recent screaming about that.

When one field gets hit, retraining is a good option. When they all get hit, it is a lot harder.

When my company got acquired, many were worried that there would be massive layoffs. In the first meeting, the person in charge of our division said that not only wouldn’t there be layoffs, but that we would be hiring.
He spoke the truth about layoffs, at least. However, he didn’t mention that all the hiring would be in India.