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

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

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

Demand-side Factors	Supply-side Factors
A fall in consumer confidence reduces consumption A fall in business confidence reduces investment Increasing levels of unemployment reduce consumption Decreasing levels of government spending Increased interest rates require borrowers to repay higher amounts on their loans - this reduces discretionary income which reduces consumption Shocks to other economies can reduce demand for a country's exports thus reducing total demand	Unexpected supply shocks such as the war on Ukraine or the Japanese Tsunami of 2011 A gradual decline in the productive capacity of the economy when capital (machinery) grows old and is not replaced A gradual decline in the level of education/training available in an economy On-going industrial action such as worker strikes which disrupt the supply of labour to an economy Weather events which destroy agricultural products or interrupt supply chains

Demand-side Factors

Supply-side Factors

A fall in consumer confidence reduces consumption
A fall in business confidence reduces investment
Increasing levels of unemployment reduce consumption
Decreasing levels of government spending
Increased interest rates require borrowers to repay higher amounts on their loans - this reduces discretionary income which reduces consumption
Shocks to other economies can reduce demand for a country's exports thus reducing total demand

Unexpected supply shocks such as the war on Ukraine or the Japanese Tsunami of 2011
A gradual decline in the productive capacity of the economy when capital (machinery) grows old and is not replaced
A gradual decline in the level of education/training available in an economy
On-going industrial action such as worker strikes which disrupt the supply of labour to an economy
Weather events which destroy agricultural products or interrupt supply chains

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

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

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

National output (rGDP) falls
More firms go bankrupt
Both unemployment and underemployment increase
Both exports and imports fall
Domestic and foreign investment by firms decreases/stops
Deflation may become an issue leading to even lower wage levels
Government spending on unemployment benefits increase
Opportunities for entrants to the workforce decrease (youth unemployment increases)
Governments may have to spend significant amounts of money to support the economy which carries several major opportunity costs

Last updated: 27 June 2024

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