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What Happens When the Economy Heads Into a Recession?

written by: Bruno Kos • edited by: Elizabeth Wistrom • updated: 8/2/2012

A common topic these days, mentioned often on a television, radio and the Internet, is what causes a recession. What happens with the economy prior to its "entrance" into something that is called a recession? Find out in this article.

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    What are the factors that contribute to a recession? At the basis of all economy is one simple rule: supply and demand. This rule is based not only on how sellers and buyers react to each other, but also on how they act on their own. Naturally, this rule has a direct effect on the complete business cycle, as the expansions (or contractions) are dependent on both availability of products and the buyer's desire to buy goods and services.

    In addition, if an economy of a certain country experiences a slowdown in manufacturing orders, experiences falling prices and rising unemployment, or basically experiences a decline in gross domestic product (GDP) growth, it is considered that this country's economy is suffering from economic recession.

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    Signs of a Recession

    There are several indicators showing that a country is suffering from recession, and some of the most common are:

    • Constant rise of unemployed people
    • Decline in profits of large companies
    • Borrowers cannot pay back various loans
    • Prices of essential commodities suddenly goes up
    • GDP goes down
    • Prices of property and cars go down, but the items remain unsold regardless

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    Theories About the Causes

    It is very hard to extract the exact causes of recession, but there are numerous theories concerning the subject. Many economists consider that events that have an economy-wide impact represent main causes of a recession. More specifically, it is considered that the primary cause of recession involves all actions that are taken to control the money supply within the economy.

    On the other hand, there is another theory that tries to explain what causes a recession. Proponents of this theory suggest that the causes should be traced to events concerning particular industries and firms. This theory has roots in the fact that some industries are affected badly during a recession and some other industries don't suffer from a recession at all.

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    Unavoidable Changes

    Economists generally believe that a recession cannot be avoided. This is simply due to the fact that every economy experiences three types of growth: high, slow, and no growth. Actually, every economy should have periods of contraction and expansion. If it does not have these periods, it is not considered "healthy.“ It is considered that the economy is in recession if it's experiencing a contraction for at least six months in a row.

    Regardless of numerous research efforts concerning recession, it is almost impossible to predict when an economy will suffer. Despite the fact that the world's economy suffered from several recessions and even the Great Depression, all the secrets and myths around their causes are still not understood.

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    References

    Jeanne M. Nagle: How a Recession Works, The Rosen Publishing Group, 2009.

    Stanislaw Gomulka: The causes of recession following stabilization, Centre for Economic Performance, London School of Economics and Political Science, 1991.