Question

1. Generally, when the economy is in a recession, what happens to inflation? How does unemployment change in a recession? Explain your answers.

2. Generally, when the economy is expanding, what happens to unemployment and inflation? Explain.

3. List and explain five factors, other than income, which can change the amount of overall consumption spending for an economy.

4. What did Keynes mean with the phrase “animal spirits”? How do animal spirits affect investment spending for an economy?

Answer 1

1) Recession is a period when the economy is contracting ie the aggregate demand is less and the production and output are reducing. Since all these is happening, the firms employ less workers because the demand for goods and services is less and this leads to more workers getting laid off.

Thus the unemployment would rise when more and more firms cut costs and workers are being laid off. So the unemployment in period of recession tends to rise.

Also there is a negative relation between unemployment and inflation ie when unemployment is less inflation is more and vice versa. So in this case, unemployment is more and so inflation is less.

When aggregate demand is less and there are inventories growing, the prices of goods and services would reduce. Also another reason is that wages are also not being given, so people would demand further less. All these factors contribute to the reduction in inflation or reduced price levels.

2) When the economy is expanding, it means that the aggregate demand for goods and services would be more. This would mean that the firms would want to produce and supply more. This in turn would increase the demand for labour and there would be more employment. This would reduce the level of unemployment.

Another thing is that when the employment increases, people would have more money to spend and the demand for goods and services would increase. This would increase the price and hence inflation would prevail.

In other words, when umemployment is reducing there is an increase in demand for goods and becasue of inverse relation between unemployment and inflation, the inflation would rise when econbomy is expanding.

(You can comment for doubts)