But sometimes the commercial and industrial basis is also decidedly unsound. The cycle of prosperity has brought an overextension in many lines, and the necessary adjustments must be more fundamental. Probably the most incisive criticism of our capitalistic system is that production is carried on without proper co-ordination of different lines, so that suddenly society finds that too much of its energy has been devoted to the production of certain things and too little to others. Capitalistic production connotes production in advance of need; it requires much time - and the different industries require different lengths of time - for the delivery of products. Capitalistic production is based on specialization, one group producing one thing which it exchanges for the things produced by other groups. The quantity of any one product that can be absorbed by the community is quite definitely related to the quantities of other goods produced for exchange. Unemployment and overproduction are but ill adjustments of this proportion. The exchange ratio (the price) of goods is the index by which the production of this or that commodity is actually controlled. Society under the capitalistic system relies upon her enterprisers to gauge and forecast these prices and to adjust production so as to maintain a relatively steady and proportioned flow of goods. In a single industrial plant the general manager so apportions the labor, materials, and space as to secure harmonious adjustment of the outputs of the various divisions. If in assembling the final product five pinions are required for every axle, the plant is organized to produce them in that proportion. But society lacks such a general organizer and administrator; each producer is free to produce what he will, in what amounts he thinks best. The result is spasmodic overproduction and underproduction in various lines. A sort of anarchy prevails, and production and consumption are in constant flux and readjustment.

This lack of correlation between supply and demand arises, therefore, from various causes: In the first place, production is made in anticipation of demand, and the interim between production and consumption varies with the commodity and is not always determinable. The demand is also difficult to estimate for it is subject to varying influences and changes often with the caprice of fashion, legislation, politics, and the like. The enterprisers, moreover, are not omniscient. In the second place, even if enterprisers were able to forecast perfectly the demand, they might not be able immediately to readjust their production, for there is a certain immobility in the factors of production; the enterpriser may logically conclude that it is better for him to run at a small loss than to shut down the whole plant; or he may decide to flood the market on purpose to drive his less able competitors to the wall. Finally, one enterpriser has no control over his competitors; he may gauge the demand perfectly, but find when he has his product ready for sale that the market is glutted with competing supplies, whereas in other lines of commodities there is a dearth.

Whatever the causes of periodic or spasmodic overproduction, it is a characteristic phenomenon of the capitalistic system that from time to time certain products can be sold only at a loss. The result is that many commercial and industrial concerns fail and also involve their creditors in ruin.

Source:  http://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Overproduction-And-Underproduction.html