Many accounts of the Industrial Revolution give demand-side forces an important role in stimulating growth. In practice the conditions under which such forces could act need to be carefully specified, and when this is done it is clear that they do not automatically produce the effects which are often attributed to them.
Suppose that the existing land, labour and capital of the country are fully employed. This being the case, on the assumptions of neo-classical economic theory the effect of additional demand, however it comes about, will not be to increase production but to either increase prices or shift output from one sector to another without it necessarily increasing in total. The reasoning behind this is simple: if the factors of production are fully employed, then whatever the demand they cannot produce more. When money supply increases as a result of increasing demand, the outlet is prices. The suggestion has often been made that, in the Industrial Revolution, rising prices became the stimulus, either to innovation, additional investment, or both. Again, given the original assumptions, this would not have happened. If all prices had risen at the same rate and simultaneously - as would occur if the demand was evenly spread - then there would not have been any additional stimulus to businessmen to economise in one way or another, for instance by developing machinery to displace labour. To put it another way, businessmen should have been looking for opportunities to economise anyway, whatever the demand conditions. Nor would there have been any possibilities of supernormal profits from rising prices which might have encouraged additional investment, since costs would have risen as fast as prices, and thus profit margins would have remained the same as before. In practice if interest rates for business borrowing were sticky, as suggested in the previous chapter, then that element of costs would have risen more slowly and there might have been some superprofits and some incentive to substitute capital for labour. But the constraints on the availability of capital and labour would still have existed: the failure of interest rates to increase would have hampered the expansion of credit, so investment would have been restricted. If the additional demand affected some sectors but not others, then as prices rose in those sectors resources would have shifted towards them. This may have given rise to some net increase in income, if, for instance, the growing sectors experienced economies of scale and the declining sectors did not. But there would still have been a decrease in output in other sectors, so the net output gain would have been limited.