Unit 4 June 2011 Essay 1: Question 07- Recession

07: Explain possible reasons for an economy moving from a period of prosperity to one of recession ( 15 marks )

A recession is when there is two or more quarters with negative economic growth. For example economic growth has been -2% in the 3rd quarter of 2008 and -4% in 4th quarter of 2008. While prosperity can be said to be the boom period which is where there were strong economic growth. These two can be shown by the economic cycle before.

From Tutor2u – Economic Cycle

The causes of recession would include:

  1. The 2008/2009 Global Recession started due to the Credit Crisis in the US. The Credit Crunch which is where due to the lack of money being able to lend to people via banks they would have to restrict on their lending. This is by higher interest rates, this can then affect aggregate demand ( total spending in the economy c+i+g+(x-m) aswell
  • Consumers would have to spend less as they would borrow less DOWN – Consumption
  • Business would be likely to invest less as they would not have the money to do so- so DOWN -Investment.
  • The interest rates going up would mean mortgages are hard to get so house prices will go down. When house prices go down people would spend less as houses is a source of wealth and therefore they would try to save this money. 
  • Overall confidence will go down- multiplier effect as a leakage from AD leads to unemployment which could then lead to these workers spending less causing the second wave of recession. So the overall loss of GDP is much bigger. 

2. Cost Push Inflation 

  • This includes the costs of food, oil and other commodities increasing in price probably due to a supply shock. 
  • This could mean higher costs for both businesses and consumption. Businesses would be facing costs so it would have tend to increase its prices. This would then see prices rise and consumption would be faced with higher costs therefore spend less.
  • However as supply decreases GDP will decrease and it is very hard to fix because both price and output have been affected.

3) One of the major components of the cause of recession is CONFIDENCE

  • As mentioned as a signifcant decrease in demand will lead to uncertainty to act for example consumers would want to save rather than spend, business would rather not invest as they don’t know what the future holds.
  • Confidence is hard to revive unless there is some sort of spending like government to boost up the economy again. 
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