Recession
What is Recession?
A recession is a significant decline in economic activity lasting more than a few months.
A recession is a period of economic contraction characterized by falling output, rising unemployment, and decreasing income. Recessions are typically identified by a decline in real GDP for at least two consecutive quarters. During a recession, businesses often cut back on production and lay off workers, leading to reduced consumer spending and further economic weakness.
Recession: a worked example
Quarterly real GDP in Sowerby runs $940B, then $932B, then $921B, then $925B. The second quarter falls by (932 minus 940) ÷ 940 × 100 = negative 0.9%. The third falls by (921 minus 932) ÷ 932 × 100 = negative 1.2%. Two consecutive quarters of declining real GDP satisfy the common rule of thumb, so Sowerby is in recession, with the peak at $940B and the trough at $921B. Measured peak to trough, output fell (921 minus 940) ÷ 940 × 100 = 2.0%. The fourth quarter rises 0.4%, which ends the contraction. Over the same stretch unemployment climbed from 4.5% to 7.5% against a natural rate of 5%, so cyclical unemployment reached 7.5 minus 5, or 2.5 percentage points.
The mistake students make with recession
The long-run aggregate supply curve gets shifted left to show a recession. Students reason that the economy is producing less, so its capacity must have shrunk, and they slide LRAS or the production possibilities curve inward. A demand-driven recession leaves capacity untouched, because the factories and workers still exist, they are simply idle. Draw it as aggregate demand shifting left, equilibrium real GDP landing to the left of an unmoved LRAS, and the economy operating at a point inside a production possibilities curve that has not moved.
Recession questions
How is a recession officially defined?
The rule of thumb is two consecutive quarters of falling real GDP, which is what most exam questions expect. Economists who date recessions officially look broader, weighing employment, real personal income, industrial production, and sales, and they can declare a recession without the two-quarter pattern appearing. Either way the measure uses real GDP, adjusted for inflation, never nominal GDP.
What is the difference between a recession and a depression?
A depression is a recession that runs far deeper and far longer, with output falling by a large fraction rather than a couple of percentage points and unemployment staying elevated for years. No numerical threshold separates the two, which is why economists use the word depression sparingly. Both describe contractions, so on an AP exam both mean actual real GDP below potential and a negative output gap.
What happens to prices during a recession?
Prices usually rise more slowly rather than actually falling. A leftward shift in aggregate demand lowers both real GDP and the price level in the simple model, but sticky wages and prices mean the practical result is disinflation, a smaller inflation rate, rather than outright deflation. A supply-side recession behaves differently: a sharp rise in input costs shifts short-run aggregate supply left, so output falls while prices rise, which is stagflation.
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Related terms
Common comparisons
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