Explain 3 Characteristics of a Recession (15 Marks)
A recession is a period in the economic cycle, in which an economy experiences two consecutive
quarters of negative growth. Often, a fall in national output, an increase in unemployment and a fall
in consumer confidence are features that occur during a recession. During a recession, economic
growth is negative and leads to a subsequent fall in GDP over a period of at least sixth months. This
fall in GDP indicates that there is a fall in the level of real national output, perhaps due to lower
consumer confidence that is causing a demand-side shock. This is shown in diagram A, in which an
inward shift of the demand curve, from AD1 to AD2, leads to a contraction in the level of national
income, from Y1 to Y2. A lower level of national income implies that there is reduced income
received by the production of goods and services, due to the lower demand for these goods and
services. Therefore, the reduced flow of output that occurs during a recession is often a feature of
recessions themselves.
A subsequent result of the fall in aggregate demand during a recession is an increase in employment
because decreased aggregate demand leads to a fall in the demand for labour. This fall in demand
may be due to an increase in the propensity to save, caused by uncertainty and lower consumer
confidence. As labour is a derived demand, a fall in aggregate demand during a recession leads to
firms deciding to reduce costs and either cut back on hiring new workers or reducing their stock of
existing workers. Additionally, due to the low demand and a lower likelihood of firms generating
profit, some firms may go bankrupt, causing all their workers to lose their jobs and, thus, lead to
increased unemployment. This form of demand deficient unemployment is seen in diagram B, in
which the fall in aggregate demand, shown in the inward shift of the demand from AD1 to AD2,
leads to a fall in GDP and thus, leads to higher unemployment. However, the extent of
unemployment experienced in a recession depends on the existing health of the economy, and its
potential for recovery. During the great recession, unemployment in the UK rose to over 2.6 million,
however other countries, particularly Greece, Spain and Portugal, have experienced unemployment
rates of over 20%, due to having a comparatively weaker economy than the UK.
Investment is the spending by firms on capital goods, such as plants and machinery, for the future
growth of the economy, but, during a recession, demand deficiency may lead to a fall in investment
by firms. This is likely to be because there is a rise in business failures during a recession, with firms
not being able to attain expected profits and revenue that is sufficient for future investment.
Diagram C illustrates that a fall in investment would cause an inward shift of the AD curve, increasing
the negative output, which further prevents businesses from investing, due to their large stocks of
unsold goods. It is important to consider the potential negative multiplier associated with a fall in
investment spending, as investment attributes 14-20% of aggregate demand. Therefore, lower
investment can lead to a further fall in output, a further increase in unemployment and an even
lower market demand, which may lead to an economy remaining in the recessionary stage of the
economic cycle. The consequences of a fall in investment are more detrimental when the health of
the economy is not strong, as the impact of reduced investment may be wider when consumer
demand is low, as it is during a recession.
Overall, the main characteristic of an economic recession appears to be the continued fall of
aggregate demand, as this feature leads to the appearance of other recession characteristics,
especially increased unemployment and a fall in business investment.
A recession is a period in the economic cycle, in which an economy experiences two consecutive
quarters of negative growth. Often, a fall in national output, an increase in unemployment and a fall
in consumer confidence are features that occur during a recession. During a recession, economic
growth is negative and leads to a subsequent fall in GDP over a period of at least sixth months. This
fall in GDP indicates that there is a fall in the level of real national output, perhaps due to lower
consumer confidence that is causing a demand-side shock. This is shown in diagram A, in which an
inward shift of the demand curve, from AD1 to AD2, leads to a contraction in the level of national
income, from Y1 to Y2. A lower level of national income implies that there is reduced income
received by the production of goods and services, due to the lower demand for these goods and
services. Therefore, the reduced flow of output that occurs during a recession is often a feature of
recessions themselves.
A subsequent result of the fall in aggregate demand during a recession is an increase in employment
because decreased aggregate demand leads to a fall in the demand for labour. This fall in demand
may be due to an increase in the propensity to save, caused by uncertainty and lower consumer
confidence. As labour is a derived demand, a fall in aggregate demand during a recession leads to
firms deciding to reduce costs and either cut back on hiring new workers or reducing their stock of
existing workers. Additionally, due to the low demand and a lower likelihood of firms generating
profit, some firms may go bankrupt, causing all their workers to lose their jobs and, thus, lead to
increased unemployment. This form of demand deficient unemployment is seen in diagram B, in
which the fall in aggregate demand, shown in the inward shift of the demand from AD1 to AD2,
leads to a fall in GDP and thus, leads to higher unemployment. However, the extent of
unemployment experienced in a recession depends on the existing health of the economy, and its
potential for recovery. During the great recession, unemployment in the UK rose to over 2.6 million,
however other countries, particularly Greece, Spain and Portugal, have experienced unemployment
rates of over 20%, due to having a comparatively weaker economy than the UK.
Investment is the spending by firms on capital goods, such as plants and machinery, for the future
growth of the economy, but, during a recession, demand deficiency may lead to a fall in investment
by firms. This is likely to be because there is a rise in business failures during a recession, with firms
not being able to attain expected profits and revenue that is sufficient for future investment.
Diagram C illustrates that a fall in investment would cause an inward shift of the AD curve, increasing
the negative output, which further prevents businesses from investing, due to their large stocks of
unsold goods. It is important to consider the potential negative multiplier associated with a fall in
investment spending, as investment attributes 14-20% of aggregate demand. Therefore, lower
investment can lead to a further fall in output, a further increase in unemployment and an even
lower market demand, which may lead to an economy remaining in the recessionary stage of the
economic cycle. The consequences of a fall in investment are more detrimental when the health of
the economy is not strong, as the impact of reduced investment may be wider when consumer
demand is low, as it is during a recession.
Overall, the main characteristic of an economic recession appears to be the continued fall of
aggregate demand, as this feature leads to the appearance of other recession characteristics,
especially increased unemployment and a fall in business investment.
