Question

1. What components of GDP tend to decline significantly during recessions (particularly during the 2008 recession), and what GDP components rise during expansion? In other words, what aspects of GDP are mostly affected when the economy slows down? and why? Neat handwriting please.

Answer 1

A recession has a domino effect, where increased unemployment leads to less growth and a drop in consumer spending, affecting businesses, which lay off workers due to losses. A recession occurs when there are two or more consecutive quarters of negative gross domestic product (GDP) growth. In other words, economic growth slows during a recession. Attributes of an economy experiencing a period of recession include a fall in sales and revenues of corporations, a fall in stock prices, falling incomes and a high unemployment rate.

When an economy is facing recession, business sales and revenues decrease, which cause businesses to stop expanding. When demand is not high enough, businesses start to report losses and first try to reduce their costs by lowering wages or keeping wages where they are and ceasing to hire new workers, which increases the unemployment rate. A decrease in the GDP causes firms that aren't recession-proof to report losses and can cause some companies to go bankrupt, resulting in massive layoffs that also increase unemployment.

Recession effects can snowball and worsen the situation. When there are massive layoffs and no jobs being created, consumers tend to save money, tightening the money supply. When there is a tightened money supply, unemployed workers and workers with low wages tend to save more and spend less, decreasing the demand for goods and services and decreasing consumer spending. This drop in demand lowers the growth rate of companies and the economy, which, in turn, leads to greater losses in non-recession-proof business and higher unemployment

A recession is when the economy declines significantly for at least six months. There's a drop in the following five economic indicators: real GDP, income, employment, manufacturing, and retail sales.

The only good thing about a recession is that it cures inflation. The Federal Reserve must always balance between slowing the economy enough to prevent inflation without triggering a recession. Usually, the Fed does this without the help of fiscal policy. Politicians, who control the federal budget, generally try to stimulate the economy as much as possible through lowering taxes, spending on social programs and ignoring the budget deficit. That's how the U.S. debt grew to $10.5 trillion before even a penny was spent on the 2009 Economic Stimulus Package, known formally as the American Recovery and Reinvestment Act.

The business cycle is the pattern of expansion, contraction and recovery in the economy. Generally speaking, the business cycle is measured and tracked in terms of GDP and unemployment – GDP rises and unemployment shrinks during expansion phases, while reversing in periods of recession. Wherever one starts in the cycle, the economy is observed to go through four periods – expansion, peak, contraction and trough.

Recession is typically used to mean a downturn in economic activity, but most economists use a specific definition of "two consecutive quarters of declining real GDP" for recession. By comparison, there is no formal definition of depression. While recessions have averaged around 10 months in length since the 1950s, the recovery/expansion phases have a much wider range of lengths, though around three years is relatively common.

The movement of the economy through business cycles also highlights certain economic relationships. While growth will rise and fall with cycles, there is a long-term trend line for growth; when economic growth is above the trend line, unemployment usually falls. One expression of this relationship is Okun's Law, an equation that holds that every 1% of GDP above trend equates to 0.5% less unemployment.

While the business cycle is a relatively simple concept, there is great debate among economists as to what influences the length and magnitude of the individual parts of the cycle, and whether the government can (or should) play a role in influencing this process. Keynesians, for instance, believe that the government can soften the impact of recessions (and shorten their duration) by cutting taxes and increasing spending, while also preventing an economy from "overheating" by increasing taxes and cutting spending during expansion phases.

In comparison, many monetarist economists disagree with the notion of business cycles altogether and prefer to look at changes in the economy as irregular (non-cyclical) fluctuations. In many cases, they believe that declines in business activity are the result of monetary phenomena and that active government inflation is ineffective at best and destabilizing at worst.