What this lesson teaches
I can define a recession, explain its causes, and describe its effects on consumers, workers, firms and government.
Syllabus K343, 4.5.4. Causes and consequences of recession: definition of recession; how 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; consequences of recession for consumers, workers, producers/firms and the government
Make a guess
Real GDP has fallen for two quarters in a row. Must prices be falling too?
- Yes, because firms cut prices in a recession to keep selling.
- No. Prices often still rise, just more slowly.
- No. Prices must stay the same, because demand and supply both fall.
Show the answer
No. Prices often still rise, just more slowly.
A recession is a fall in real output. Weak demand usually slows price rises, but prices need not fall.
A recession is a period of falling real GDP, caused by lower demand or fewer or worse resources.
A recession is a period when real GDP falls. A common definition is two quarters in a row of falling real GDP.
A fall in total demand is the most common cause. Households may lose confidence and cut spending, firms may cut investment, or foreign demand for exports may fall. A recession can also come from a fall in the quantity or quality of resources, for example after a natural disaster or a pandemic.
Consequences. Consumers: incomes fall and confidence drops. Workers: unemployment rises, and those in work may face pay cuts. Firms: sales and profits fall, some close.
The government collects less tax, especially from income and company tax, but must spend more on benefits. Its budget moves towards deficit.
Put these in order
Demand for a country's exports falls sharply. Put the chain to a recession in order.
- Other firms cut output and jobs too.
- Households spend less in shops and restaurants.
- Real GDP falls for two quarters in a row: a recession.
- Exporters cut output and lay off workers.
- Foreign buyers order fewer exports.
Show the answer
- Foreign buyers order fewer exports. Exporters' sales fall, so they need to produce less.
- Exporters cut output and lay off workers. The workers who lose their jobs have less income to spend.
- Households spend less in shops and restaurants. Lower spending cuts sales at firms that have nothing to do with exports.
- Other firms cut output and jobs too. The fall in spending spreads across the economy, so total output keeps falling.
- Real GDP falls for two quarters in a row: a recession.
- Recession
- Fall in real GDP, often two consecutive quarters.
- Causes
- Lower total demand, or fewer/worse resources.
- Consequences
- Lower incomes, higher unemployment, lower profits, budget deficit.
Worked example: A recession caused by falling exports
Suppose demand for a country's electronics falls sharply because its trading partners are in recession.
- Exports fall, so electronics firms cut output and lay off workers.
- Those workers spend less, so shops and restaurants lose sales too.
- Real GDP falls for two quarters in a row: a recession.
- Government: tax revenue falls while spending on support schemes rises.
Watch out for this
A recession means prices are falling.
A recession is a fall in real output. Prices may still rise, but usually more slowly, because demand is weak.
Check your understanding
Which is a likely consequence of a recession for the government?
- Tax revenue rises, because people save more and pay tax on their interest.
- The budget surplus grows, as the government spends less during hard times.
- Tax revenue falls while spending on benefits rises.
Show the answer
Tax revenue falls while spending on benefits rises.
Right. Lower incomes and profits mean less tax, and more people need support.
Check your understanding
Which is most likely to happen during a recession?
- Firms invest more in new factories
- Tax revenue rises as incomes grow
- Inflation rises sharply as demand grows
- Unemployment rises as firms cut output
Show the answer
Unemployment rises as firms cut output
Right. With falling sales, firms need fewer workers and lay some off.