Question

The US economy has recently experienced one of the worst recessions after the Great Depression of the 1930s; that is why most people called it the Great Recession (Dec 2007-June 2009). The effects of this recession are still felt all across the country: Currently the unemployment rate is 3.9% and about 700,000 people have not worked for a whole year. In addition, in 2009, real GDP dropped 2.9% and the inflation rate was negative (there was deflation!). Also, in October 2009 the unemployment rate reached 10.2%. Moreover, as a result of the recession, the unemployment rate was greater than 4% for more than 10 years.

Note: Real GDP is a measure of total production in the economy (in a year); and when the unemployment rate is 4% (that is, when we have “full employment”), the economy is doing very well.

Explain why a significant slowdown in the economy (a drop in real GDP, a recession) causes...

a) an increase in unemployment (5 POINTS), and

b) a fall in prices (deflation) (5 POINTS).

Answer 1

a. When an economy faces a significant shutdown in the growth or fall in real GDP or faces the recession, the number of unemployed workers around the economy starts to increase rapidly as during recession economy faces a contraction on growth, less business demand, less investment . Thus to minimize the production cost, firms start to lay off their workers in ahuge number that increases the unemployment rate . Along with this, getting new job during recession is quite difficult due to less demand for business and less investment as people tends to save more unemployment rate constantly increases during recession.

b.Due to recession , due to fall in real GDP consumers starts to spend less and save more, demand starts to fall, firms have larger amount of unsold goods due to increasing unemployment rate , households expectation starts to fall , all these contractionary situation leads to have a fall in agg demand of the economy thus price level falls drastically with a fall in real GDP.