Causes & Consequences of Recessions (Cambridge (CIE) O Level Economics)

Causes of Recessions

• A recession is a period of at least six months (2 quarters) of economic decline which causes a decrease in the real gross domestic product (rGDP)

• It can be caused by a fall in any of the factors that influence total demand (consumption, investment, government spending, net exports) e.g. consumption fell during Covid 19 lockdowns causing many economies to experience a recession

• It can also be caused by supply-side shocks that create challenges for firms and consumers. E.g. The Russian war on the Ukraine has reduced the supply of natural gas, oil and petrol resulting in major disruptions and increased energy costs
   

Factors That Reduce Total Demand and Total Supply

• The economic decline (recession) caused by supply-side interruptions can be illustrated using a production possibility curve (PPC)

Diagram explanation

• Economic decline occurs when there is any impact on an economy that reduces the quantity or quality of the available factors of production as depicted by the movement A

  • One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated the production possibilities of Japan for many years. It shifted their PPC inwards causing economic decline

Consequences of Recessions

• The consequences of a recession depend on the severity and length of the recession. E.g. The Great Depression lasted from 1929 to 1939 whereas some economies are in and out of recession within a year

1. National output (rGDP) falls

2. More firms go bankrupt

3. Both unemployment and underemployment increase

4. Both exports and imports fall

5. Domestic and foreign investment by firms decreases/stops

6. Deflation may become an issue leading to even lower wage levels

7. Government spending on unemployment benefits increase

8. Opportunities for entrants to the workforce decrease (youth unemployment increases)

9. Governments may have to spend significant amounts of money to support the economy which carries several major opportunity costs