How a recession may be caused by a decrease in total demand, a decrease in the quantity of resources or a decrease in the quality of resources

Published by Patrick Mutisya · 14 days ago

IGCSE Economics 0455 – Government and the Macro‑economy: Economic Growth

Economic Growth and Recession

Economic growth is an increase in the total value of goods and services produced by an economy over a period of time, usually measured by real Gross Domestic Product (GDP). A recession is a period of falling real GDP, typically identified when output contracts for two consecutive quarters.

Key Question

How can a recession be caused by:

  1. A decrease in total (aggregate) demand

  2. A decrease in the quantity of resources (factors of production)

  3. A decrease in the quality of resources

1. Decrease in Total Demand

Total demand, or aggregate demand (AD), is the total amount of goods and services that households, firms, the government and the foreign sector are willing and able to buy at a given price level.

The AD equation can be expressed as:

\$AD = C + I + G + (X - M)\$

where:

  • \$C\$ = consumption expenditure

  • \$I\$ = investment expenditure

  • \$G\$ = government spending

  • \$X\$ = exports

  • \$M\$ = imports

A fall in any of these components shifts the AD curve leftwards, reducing output and creating a recessionary gap.

  • Consumption fall: caused by higher interest rates, reduced consumer confidence, or higher taxes.

  • Investment fall: caused by tighter credit conditions, lower expected profits, or increased business taxes.

  • Government spending cut: fiscal consolidation or austerity measures.

  • Net export decline: caused by a stronger domestic currency or a global economic slowdown.

Suggested diagram: AD‑AS model showing a leftward shift of AD leading to a lower equilibrium output (recessionary gap).

2. Decrease in the Quantity of Resources

The quantity of resources refers to the amount of labour, capital, land and entrepreneurship available for production.

When the supply of any factor falls, the economy’s productive capacity (potential output) contracts, shifting the long‑run aggregate supply (LRAS) curve leftwards.

  • Labour supply reduction: caused by higher unemployment, emigration, ageing population, or health crises.

  • Capital stock reduction: caused by natural disasters destroying factories, reduced investment, or depreciation outpacing replacement.

  • Land and natural resources: depletion of mineral reserves or severe droughts that limit agricultural output.

With a smaller LRAS, even if AD remains unchanged, the equilibrium level of real GDP falls, creating a recessionary gap.

Suggested diagram: LRAS shifting leftwards while AD remains constant, showing a lower level of real GDP.

3. Decrease in the Quality of Resources

Quality of resources refers to the productivity of labour (skills, education, health) and the efficiency of capital (technology, management). A decline in quality reduces the amount of output that can be produced from a given quantity of resources.

  • Labour quality decline: reduced education standards, loss of skills through migration, or widespread illness.

  • Capital quality decline: outdated technology, poor maintenance, or low levels of research and development.

  • Entrepreneurial quality decline: reduced innovation, weaker business confidence, or restrictive regulations that stifle enterprise.

These factors shift the short‑run aggregate supply (SRAS) curve leftwards because firms face higher per‑unit costs or lower productivity, leading to higher prices and lower output – a stagflation‑type recession.

Suggested diagram: SRAS shifting leftwards while AD stays unchanged, illustrating higher price level and lower output.

Summary Table

Cause of RecessionMechanismTypical Shift in AD‑AS ModelPolicy Response (Typical)
Decrease in total demandFall in C, I, G or (X‑M); lower consumer/business confidenceAD shifts leftExpansionary fiscal policy (increase G or cut taxes); expansionary monetary policy (lower interest rates)
Decrease in quantity of resourcesReduced labour, capital or land; natural disasters, emigrationLRAS shifts leftSupply‑side measures: training programmes, immigration incentives, investment in infrastructure
Decrease in quality of resourcesLower skills, outdated technology, poor healthSRAS shifts leftEducation and health investment; R&D subsidies; deregulation to encourage innovation

Key Points to Remember

  • A recession can arise from demand‑side, supply‑side (quantity) or supply‑side (quality) factors.

  • Demand‑side shocks move the AD curve; quantity shocks move LRAS; quality shocks move SRAS.

  • Policy measures differ: demand shocks are usually tackled with fiscal/monetary stimulus, while supply shocks require long‑term structural policies.

  • Understanding the underlying cause is essential for choosing the appropriate policy response.