The under consumption theory was introduced by two economists, Foster and Catchings. The explanation of this theory is based on the circular flow of National Income. You must have heard that the income is distributed into two parts i.e. savings and consumption, and the economy is in a state of equilibrium where these two factors determine it.

The entrepreneurs distribute the rewards to the factors of production for their respective services and thus flow of money is generated to the households. The households then use this money for consumption purposes and hence consumer’s expenditure directs the money flow back to the entrepreneurs. As a result of this equilibrium between saving and investment is attained and there is no disparity between the two. However, if at this stage is increased, more saving leads to over investment thus more production of goods i.e. consumer goods. Over-saving indicates the meaning of under-consumption. As a result of over-production due to over-savings, the people are unable to purchase the consumer goods because the people in general have reduced the consumption expenditure due to over savings. This result in prices of consumer goods going down, entrepreneurs incur losses and thus the expansion generated by over saving to an end due to under consumption and the country falls into a state of depression.

Now the question arises, “why can’t the problem of under consumption be solved by providing bank credit to the consumers to increase their purchasing power in order to stop the economy from going into a further depression”?

Foster and Catchings reply this with…

1. Loans are generally give to entrepreneurs and not to consumers and when if loans are given to entrepreneurs during this particular period they would make further investment and thus the situation is further aggravated rather than corrected because the consumption level will be further reduced.


2. Even if the loans are given to the consumers this would not change the situation because bank credit is given on the basis of reserve ratio due to which there is a limit to the expansion of credit. When this limit is reached banks stop giving credit. During the expansion of credit consumer have excess purchasing power which is an incentive for entrepreneurs to produce more consumer goods. When the limit to credit expansion arrives, further credit is stopped hence, problem of under-consumption crops up again and eventually leads to a depression. Hence, according to Foster and Catchings banks can only postpone the crisis, not overcome it.

Although this theory clearly emphasizes the phase of depression period, if however does not clearly explain the other phases of trade cycle. This theory is rather improper in the sense that the two economists say that as a result of over-saving there is more production of consumer goods which are wasted as the people cannot purchase them. However, practically, the more the factors of production produce, the more they will be rewarded and their purchasing power increases and therefore, there will not be any problem of under consumption.