A major problem with capitalism is the working of the capitalist market itself. For the supporters of "free market" capitalism, the market provides all the necessary information required to make investment and production decisions. This means that a rise or fall in the price of a commodity acts as a signal to everyone in the market, who then respond to that signal. These responses will be co-ordinated by the market, resulting in a healthy economy. For example, a rise in the price of a commodity will result in increased production and reduced consumption of that good, and this will move the economy towards equilibrium.
While it can be granted that this account of the market is not without foundation, its also clear that the price mechanism does not communicate all the relevant information needed by companies or individuals. This means that capitalism does not work in the way suggested in the economic textbooks. It is the workings of the price mechanism itself which leads to booms and slumps in economic activity and the resulting human and social costs they entail. This can be seen if we investigate the actual processes hidden behind the workings of the price mechanism.
When individuals and companies make plans concerning future production, they are planning not with respect of demand now but with respect to expected demand at some future time when their products reach the market. The information the price mechanism provides, however, is the relation of supply and demand (or market price with respect to the market production price) at the current time. While this information is relevant to people's plans, it is not all the information that is relevant or is required by those involved.
The information which the market does not provide is that of the plans of other people's reactions to the supplied information. This information, moreover, cannot be supplied due to competition. Simply put, if A and B are in competition, if A informs B of her activities and B does not reciprocate, then B is in a position to compete more effectively than A. Hence communication within the market is discouraged and each production unit is isolated from the rest. In other words, each person or company responds to the same signal (the change in price) but each acts independently of the response of other producers and consumers. The result is often a slump in the market, causing unemployment and economic disruption.
For example, lets assume a price rise due to a shortage of a commodity. This results in excess profits in that market, leading the owners of capital to invest in this branch of production in order to get some of these above-average profits. However, consumers will respond to the price rise by reducing their consumption of that good. This means that when the results of these independent decisions are realised, there is an overproduction of that good in the market in relation to effective demand for it. Goods cannot be sold and so there is a realisation crisis as producers cannot make a profit from their products. Given this overproduction, there is a slump, capital disinvests, and the market price falls. This eventually leads to a rise in demand against supply, production expands leading to another boom and so on.
Proudhon described this process as occurring because of the "contradiction" of "the double character of value" (i.e. between value in use and value in exchange). This contradiction results in a good's "value decreas[ing] as the production of utility increases, and a producer may arrive at poverty by continually enriching himself" via over-production. This is because a producer "who has harvested twenty sacks of wheat. . . believes himself twice as rich as if he had harvested only ten. . . Relatively to the household, [they] are right; looked at in their external relations, they may be utterly mistaken. If the crop of wheat is double throughout the whole country, twenty sacks will sell for less than ten would have sold for if it had been as half as great." [The System of Economical Contradictions, p. 78, pp. 77-78]
This, it should be noted, is not a problem of people making a series of unrelated mistakes. Rather, it results because the market imparts the same information to all involved and this information is not sufficient for rational decision making. While it is rational for each agent to expand or contract production, it is not rational for all agents to act in this manner. In a capitalist economy, the price mechanism does not supply all the information needed to make rational decisions. In fact, it actively encourages the suppression of the needed extra information concerning the planned responses to the original information.
It is this irrationality and lack of information which feed into the business cycle. These local booms and slumps in production of the kind outlined here can then be amplified into general crises due to the insufficient information spread through the economy by the market. However, disproportionalities of capital between industries do not per se result in a general crisis. If this was that case the capitalism would be in a constant state of crisis because capital moves between markets during periods of prosperity as well as just before periods of depression. This means that market dislocations cannot be a basis for explaining the existence of a general crisis in the economy (although it can and does explain localised slumps).
Therefore, the tendency to general crisis that expresses itself in a generalised glut on the market is the product of deeper economic changes. While the suppression of information by the market plays a role in producing a depression, a general slump only develops from a local boom and slump cycle when it occurs along with the second side-effect of capitalist economic activity, namely the increase of productivity as a result of capital investment, as well as the subjective pressures of class struggle.
The problems resulting from increased productivity and capital investment are discussed in the next section.