🌊 Decrease in quantity
The country loses resources. A flood destroys farmland and factories, or workers leave the country, so fewer goods can be made.
Economic Growth » Recession
What you'll learn this session
Study time: 30 minutes
Cambridge spec: 4.5.4
- What a recession is and how it is commonly defined
- Three causes of a recession: less total demand, fewer resources, lower quality resources
- The consequences of a recession for consumers, workers, firms and the government
- How to write a clear cause and consequence chain in an exam
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Unlock This CourseWhat is a recession?
Most of the time an economy grows. Sometimes it goes the other way and real GDP falls. A bad fall is called a recession, and it hurts almost everybody.
Key terms:
- Recession: a period when the output of an economy falls. It is commonly defined as two consecutive quarters (six months in a row) of falling real GDP.
Notice that it is real GDP, so rising prices cannot hide the fall. Remember too that economic growth means a rise in real GDP. A recession is the opposite: the economy is shrinking, not growing.
The "two quarters" rule is the common definition. A single bad quarter does not count, because one weak quarter might be a short blip.
Cause 1: a decrease in total demand
Remember that total demand is all the spending on the country's goods and services. In a recession it falls: spending by consumers, firms, the government or overseas buyers drops. Firms cannot sell as much, so they cut production and real GDP falls.
Example: in the made-up country of Merridan, shoppers become worried about losing their jobs and spend 8% less. Shops order less from factories, and factories cut output. Real GDP falls.
Causes 2 and 3: fewer or poorer resources
A recession can also come from the supply side. If a country can produce less, real GDP falls even if people still want to buy.
🔧 Decrease in quality
Resources become less productive. Machines wear out and are not replaced, or workers' skills fall out of date, so each one produces less.
Remember from the lesson on the quantity and quality of resources that both can go down as well as up. This is the same idea as an inward shift of the production possibility curve: the economy is able to produce less than before.
Three causes to remember
A recession may be caused by a decrease in total demand, a decrease in the quantity of resources, or a decrease in the quality of resources. Say which one you mean and explain the chain.
Consequences of a recession
When output falls, there is less income and less work to go round. The effects are different for each group.
🛍️ Consumers
Incomes are lower or less secure, so consumers can afford fewer goods and services. Many cut back on non-essentials and fall behind with loan repayments.
👷 Workers
Firms stop hiring and may make workers redundant, so unemployment rises. Those still in work may get smaller pay rises or fewer hours.
🏭 Producers and firms
Sales and profits fall. Firms cut output and investment, and some may close down completely.
🏦 The government
Tax revenue falls because incomes, spending and profits are lower. Spending on unemployment benefits rises, so the budget deficit tends to grow.
The consequences feed each other. Fewer jobs means less spending, which means lower sales, which means more job losses. This is why a recession can be hard to escape.
Example: in Merridan, a clothing firm sells 20% fewer shirts. It cuts working hours and lays off 50 workers. Those workers have less to spend, and the tax they paid to the government is lost.
The type of unemployment that a recession creates is covered later in the course, in the lesson on types of unemployment.
Common mistakes
- Calling any fall in GDP for a few weeks a recession. The common definition is two consecutive quarters of falling real GDP.
- Writing "prices fall" as the definition. A recession is about falling output, not prices.
- Giving only the effects on consumers. Name the group you are asked about: consumers, workers, firms or government.
- Saying the government gains from a recession. Its tax revenue falls and its spending on benefits rises.
Exam-style question
The country of Kalvedo has had two quarters in a row in which real GDP fell. Many shops and factories have closed, and shoppers say they are afraid of losing their jobs.
(a) Define a recession. [2 marks]
(b) Explain one possible cause of a recession. [3 marks]
(c) Analyse one consequence of a recession for workers and one for the government. [5 marks]
Model answer
(a) A recession is a period when output falls (1). It is commonly two consecutive quarters of falling real GDP (1).
(b) A recession may be caused by a decrease in total demand (1). If consumers are afraid of losing their jobs, they spend less (1). Firms then sell less and cut production, so real GDP falls (1).
(c) Workers (2 marks) and government (3 marks). For workers: firms sell less, so they make some workers redundant (1), and unemployment rises, so workers lose their income (1). For the government: incomes and profits fall, so tax revenue falls (1). More people claim unemployment benefits, so government spending rises (1) and the budget deficit may grow (1).
Exam tip
In part (c), the command word "Analyse" needs a chain of cause and effect for each consequence. Use "so" or "which means" to link each step, and keep workers and government separate.