Chapter 7
Understanding Why
Recessions Happen
In a nutshell, recessions happen when the total demand for goods and
services is less than the amount of goods and services being produced.
It's just like a store that has order too much inventory from it's
suppliers---more than it can sell.
What typically happens with a store in such a
situation, however, is that it simply has a sale. The lower sale
prices induce customers to buy up the excess inventory.
The problem with economies as a whole, however, is
that cutting prices across the board during a recession is much harder.
In particular, as I point out in
Economics for Dummies,
it's really hard to cut the prices of many goods and services because the
only way you can do so is if you cut workers' wages. That is, if you
are running a hair salon and sales are slow and you want to cut the price of
a haircut to increase sales, the only way you can do that is to cut the
wages you pay to your employees. But if you do that, they'll very
likely get angry and do a bad job and cost you lots of business. For
any firms in such a situation, it is almost impossible to cut prices.
The result is that you get a recession---a situation where there is lots of
unused productive capacity.
Here is a great article that appeared in
The
Economist. It details the great research of Professor Truman
Bewley of Yale University, who showed just how reluctant firms are to cut
wages in a recession---and how that makes it impossible to cut prices and
get the economy moving again quickly.
