How Recessions Work
On Jan. 21, 2008, stock prices tumbled around the world. Most analysts pointed to fears surrounding the United States economy and a possible recession as the reason for the drop. Ironically, economic conditions in the United States were affecting the world economy on a day when its own markets weren’t even in session — they were closed for the Martin Luther King Jr. Day holiday. Three days later, news outlets were already reporting a new economic stimulus package, designed in part to try to prevent a recession.
This isn’t the first recession news in recent memory. On Nov. 26, 2001, the news media announced the United States was officially in a recession and had been since March of that year. To most Americans, this wasn’t all that surprising: Rising unemployment and a weak stock market had been in the news for months.
Both the 2008 market drop and the 2001 news blitz raised a lot of questions. Who decides when the economy is in recession, and on what grounds? What actually constitutes a recession, anyway? When a nation’s economy enters a recession, is life guaranteed to get harder for most of its citizens? And how often does a recession lead to a depression?
In this article, we’ll find out what recessions are, see why they occur and examine the criteria economists use to identify them. We’ll also look at the effects of recession as well as explore some of the ways a country can turn the economy around again.
American History: The Great Depression
In 1929, the stock market crashed, and the American Dream turned into a nightmare of hunger, unemployment and hopelessness. In farming communities, the Dust Bowl added to the problems of the Great Depression. (July, 2008)
Money Makes the World Go Round
Photo courtesy NARA
In the Great Depression of the 1930s and ’40s, laid-off U.S. workers lined up daily at employment agencies.
A recession is a prolonged period of time when a nation’s economy is slowing down, or contracting. Such a slow-down is characterized by a number of different trends, including:
* People buying less stuff
* Decrease in factory production
* Growing unemployment
* Slump in personal income
* An unhealthy stock market
By the conventional definition, this slow-down has to continue for at least six months to be considered a recession.
This definition really raises more questions than it answers. What does it mean for the economy to slow down? Why does this happen? How are all these factors related? And what exactly is “the economy”?
People talk about the U.S. economy as an independent entity, but it is actually the result of millions of people’s actions. Economists use all kinds of esoteric terms to describe the connection between people’s actions and the economy as a whole. But you can understand the basic idea of this connection by looking at only a few basic concepts: producers, consumers, markets, supply and demand.
Producers and Consumers
Broadly speaking, a nation’s economy is the production and consumption of goods (food, clothes, cars) and services (repairs, lawn-mowing, haircuts) in that nation. Anybody producing or consuming things in a country (and that’s just about everybody) plays some role in the economy.
share prices board
YOSHIKAZU TSUNO/AFP/Getty Images
A pedestrian passes before a share prices board in Tokyo,
Jan. 22, 2008.
Production and consumption are intertwined. In order for people to consume things, someone has to produce those things. And in order to produce things, you need to consume things (you need to consume natural resources and people’s labor, for example).
Markets
stock board
MIKE CLARKE/AFP/Getty Images
People walk past a stock board displaying the Hang Seng Index in Hong Kong,
Jan. 22, 2008.
In a market economy, or a modified market economy such as the U.S. economy, production and consumption are connected in various “markets.” A market is simply a place where consumers can go to buy things from producers and producers can go to sell things to consumers.
A grocery store is an example of a physical market. People who want to consume food go to the grocery store and buy it from producers through a series of middlemen. The store itself is one of the middlemen, and there are usually others along the way (distribution companies, for example). The labor market is a more abstract sort of market. In this market, businesses who want to consume work pay people to produce labor. In the stock market, consumers and producers buy and sell percentages of ownership of companies (see How Stocks and the Stock Market Work for more information).
As you can see, almost everybody is both a producer and a consumer acting in more than one market. If you have a job, you are a producer of labor. Whenever you go shopping, you are a consumer of goods.
Supply and Demand
The ultimate goal of producers is to make money — to bring in more money than they spent producing the product. Consumers may want to satisfy their wants and needs by buying products, or they may buy products in order to make money (by reselling the products or by using the products to produce other products). In any case, consumers generally want to pay as little for goods and services as they can.
supply and demand
© Photographer: Jason Yoder | Agency: Dreamstime.com
The supply curve and the demand curve — where they meet determines the price of a particular item or service.
In a market, the actions of producers and consumers determine the value of goods and services. Producers are the ones who actually set prices, but they do so based on the behavior of consumers. If nobody buys a product at a particular price, the producer knows the price is too high. If some consumers buy it, but not enough to buy everything produced, producers must either decrease the price or decrease the supply. The willingness of consumers to pay for products is known as demand. Even if there is constant high demand for a product (toilet paper, for example), individual producers need to keep the price down or consumers will just buy it from a competitor.
In the next couple of sections, we’ll see how all these factors work in a growing economy and in a contracting economy.
Source: how stuff work
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