I think the problem, at least how it is typically put forward in economics is that the increase in wages leads to an increase in demand. When demand increases, prices increase as well as supply.
As long as supply is expanding fast enough to meet demand, why do you think prices would rise?
Inflation is caused by insufficient supply to meet demand. It's not caused by any particular demand level.
As a result of the increase in supply, there is eventually over production.
Businesses work hard not to over produce, and when they do over produce, it's a temporary thing, they cut back production as soon as they realize that inventories are rising. Any miscalculation doesn't happen with every producer in ever industry at the same time, it's staggered.
people must be laid off, which leads to a decline in demand, which results in downward pressure on wages, which leads to a further decline in demand, etc. Something like that. Let me know if you think I got something wrong.
Not if there is no over production. But even if there was a temporary decline in demand for a particular product, there would also be a corresponding decline in price as producers sought to clear out excess inventory, which would cause the quantity demanded to rise until the over production was absorbed. And yes, if this did happen there would likely be layoffs, but only in the particular industry/employer who had miscalculated demand.
I think you focus way too much on overproduction. You have to remember that most producers don't produce anything until an order is placed. If all they are doing is meeting those orders, then they are meeting demand, no more and no less.
Think about Walmart, or any other retailer. They determine what the optimal quantity of a particular product is to have in stock in their stores. They don't exceed that quantity, and they only order more units when they sell more units, and they only order the amount of units sold.
Factories only produce the number of units that they have orders for, and typically they warehouse far fewer goods than they used to. The last time I had a real job, I worked in a plant that made tennis balls. We had a sales manager and a production manager, and these people met daily to determine the number of units that we needed to produce that day, and the number that we needed to schedule during the up-coming weeks. Everything that we produced was shipped to the distribution centers, or even individual stores, with 24 hours of it being produced. The minute that sales started to become week, or that we had more than a few days of production on hand, we would cut back a shift, and the minute that we had customers complaining that we weren't shipping fast enough, we would add a shift. Inventory shortages and inventory overages of established products in a mature market are corrected within days.
About the only time when this doesn't happen is when it is a new product, and producers have no clue how many they will sell, or in the case that some odd external factor significantly effects demand (like a couple of years ago, idiots thought that Obama was going to take away their guns, so they flooded to the gun stores to purchase more). In this case, there may be shortages or excess production which can't be cleared in a matter of weeks, but that doesn't really effect our entire economy, only those specific producers.
Our economy is pretty much self healing, which is why we always recover from recessions. Economic cycles only occur due to irrational bubbles, such as the dot.com bubble or the sub-prime mortgage bubble, or due to temporary artificial shortages, such as the OPEC embargos of the 1970's and early '80s. If we could eliminate these irrational bubbles and artificial shortages, we could have growth at a constant rate...forever.