Question

From a spending model perspective, explain the causes of a recession.

To get you started, consider that our recent recession seems to demonstrate that expenditures and incomes depend on each other.

If markets do not self-adjust, how can a decline in spending lead to a negative process that ruins an economy? (Consider implications of gaps in the "Keynesian Cross" and/or the "Aggregate Demand/Aggregate Supply Diagram" to illustrate your points.)

Hints -- Within your answers, consider the following:

--Identify and summarize the market dynamics triggered by changes in leakages and injections.

--What role do measures like GDP, unemployment and inflation play in different scenarios?

--How do propensities and multipliers, and even expectations affect the outcomes?

Answer 1

Recession : Downfall of economy because of slowing down of economic activities in a country which leads to economical problems is called Recession

As per implications of gaps in the Keynesian Cross supply model, if the aggregate expenditure line intersects the 45-degree line at the level of potential GDP, then the economy is in sound shape. There is no recession, and unemployment is at the natural rate–what we call full employment. But there is no guarantee that the equilibrium will occur at the potential GDP level of output. The equilibrium might be higher or lower.

The distance between an output level like E₀ that is below potential GDP and the level of potential GDP is called Recessionary gaps . Because the equilibrium level of real GDP is so low, firms will not wish to hire the full employment number of workers, and unemployment will be high.

GDP, unemployment and inflation play in different scenarios:

People often say a recession is when the GDP growth rate is negative for two consecutive quarters or more.

People will experience the highest unemployment rates during the recession.

Inflation decreases during recessions and increases during expansions

The multiplier effect comes about because injections of new demand for goods and services into the circular flow of income stimulate further rounds of spending – in other words “one person’s spending is another’s income”

The value of the multiplier depends on:

• Propensity to import
• Propensity to save
• Propensity to tax
• Amount of spare capacity
• Avoiding crowding out