The term over-production is often used to describe that situation which initiates a period of capitalist crisis or recession, whereby too many goods have been produced, the goods cannot be sold, production grinds to a sudden halt, people lose their jobs, demand drops even further, and the downward cycle accelerates.
Over-production is a misnomer however, for in itself overproduction of goods is almost always a socially useful thing, easing the distribution problem and acting as an insurance against future disruption.
The real problem when goods lie on the shelves is that no-one can afford to buy the commodities; in other words over-production should really be called under-consumption.
In another sense however, the term overproduction is valid; but it is not goods and services which have been over-produced, but capital.
During a boom period – the rising phase of a capitalist crisis – profits run high and a mountain of fictitious capital is built-up by speculation and borrowing for unwarranted future expansion. All this fictitious capital has to be fed by the surplus extracted from workers and this grows to be more and more of a burden on the backs of the workers until profitability can no longer be maintained, and slump takes over.
Overproduction is the accumulation of unsalable inventories in the hands of businesses. Overproduction is a relative measure, referring to the excess of production over consumption. The tendency for an overproduction of commodities to lead to economic collapse is specific to the capitalist economy. In previous economic formations, an abundance of production created general prosperity. However in the capitalist economy, commodities are produced for profit. This so-called profit motive, the core of the capitalist economy, creates a dynamic whereby an abundance of commodities has negative consequences. In essence, an abundance of commodities disrupts the conditions for the creation of profit.
The overproduction of commodities forces businesses to reduce production in order to clear inventories. Any reduction in production implies a reduction in employment. A reduction in employment, in turn, reduces consumption. As overproduction is the excess of production above consumption, this reduction in consumption worsens the problem. This creates a "feed-back loop" or "vicious cycle", whereby excess inventories force businesses to reduce production, thereby reducing employment, which in turn reduces the demand for the excess inventories. The general reduction in the level of prices (deflation) caused by the law of supply and demand also forces businesses to reduce production as profits decline. Reduced profits render certain fields of production unprofitable.
According to Marx, in capitalism, improvements in technology and rising levels of productivity increase the amount of material wealth (or use values) in society while simultaneously diminishing the economic value of this wealth, thereby lowering the rate of profit—a tendency that leads to the paradox, characteristic of crises in capitalism, of “poverty in the midst of plenty,” or more precisely, crises of overproduction in the midst of underconsumption.
John Maynard Keynes formulated a theory of overproduction, which led him to propose government intervention to ensure effective demand. Effective demand are levels of consumption which corresponds to the level of production. If effective demand is achieved then there is no overproduction because all inventories are sold. Importantly, Keynes acknowledged that such measures could only delay and not solve overproduction.