That's because you're stopping too soon with option 2. There are actually two sub-options to option 2:
2a. Some of the laborers are fired, and they can't find any other work so they now aren't producing anything (time and production stay constant, laborers decrease).
2b. Some of the laborers are fired, and that means a pool of unused labor now exists, which entrepreneurs hire to do new jobs that couldn't be done at all before because there was no labor available (time and laborers stay constant, production increases).
Outcome 2a will virtually never happen in a healthy economy because there are always more things that people want, so there are always additional things that could be produced if labor were available. So what actually happens, at least in a healthy economy, is outcome 2b. If you're seeing outcome 2a, it means the economy is not healthy: something is preventing the natural process of labor that is no longer needed for existing production being redirected into new production. Almost always that something is the government.
That's because you're stopping too soon with option 2. There are actually two sub-options to option 2:
2a. Some of the laborers are fired, and they can't find any other work so they now aren't producing anything (time and production stay constant, laborers decrease).
2b. Some of the laborers are fired, and that means a pool of unused labor now exists, which entrepreneurs hire to do new jobs that couldn't be done at all before because there was no labor available (time and laborers stay constant, production increases).
Outcome 2a will virtually never happen in a healthy economy because there are always more things that people want, so there are always additional things that could be produced if labor were available. So what actually happens, at least in a healthy economy, is outcome 2b. If you're seeing outcome 2a, it means the economy is not healthy: something is preventing the natural process of labor that is no longer needed for existing production being redirected into new production. Almost always that something is the government.