What Are the Causes of Economic Decline?

by Matthew Lutmer-Paulson

Economists measure economic decline by measuring the income for the entire economy, which is called gross domestic product or GDP. Six straight months of negative GDP growth is the standard definition for a recession. In practical terms, this means that there are fewer jobs available and generally less wealth is being generated in the economy as a whole. There are many reasons why an economy might decline and economists do not always agree on what those factors might be.

High Unemployment

Some economists believe that high unemployment will prolong a recession. This occurs because businesses earn less profit during a recession and lay off workers, which leads to less demand for products. If enough workers lose their jobs throughout the economy, then many businesses will earn less in profits and lay off more workers. The cycle repeats itself many times over and the result is high unemployment of 10 percent or more, which makes it difficult for the economy to recover.

Inflation

Inflation is the gradual rise in prices over time. When wages increase, businesses may raise prices to compensate. This causes workers to demand higher wages, which lead to even higher prices and still higher wages. When inflation becomes high, the economy will have a hard time increasing growth because increased wages only lead to higher costs. Businesses and consumers increase spending to keep up with higher prices, but fewer jobs and less wealth are being generated.

HIgh Oil Prices

Oil is a necessary ingredient in almost every production process in the economy. If oil prices rise too quickly, the economy can decline because businesses will be forced to increase spending on raw materials. That means they'll produce fewer products at the same time that workers will be demanding higher wages to pay for their own increased gasoline costs. High oil prices can then cause higher inflation and higher unemployment, which leads to economic decline.

Government Spending and taxes

Some economists believe that increased government spending can reduce business investment and therefore decrease economic growth. If businesses buy government debt instead of buying more machines or hiring more workers, the economy will decline. High taxes can also cause businesses to produce fewer products or hire fewer workers. Businesses will leave high tax areas and move to other states or countries where taxes are lower, leading to fewer jobs and less wealth in the states and countries that the businesses left. .

About the Author

Matthew Lutmer-Paulson is a high school government and economics teacher, as well as a junior college adjunct government instructor. He earned a Bachelor of Science in political science from Texas A&M University-Commerce, and holds a Master of Science in political science from the University of Texas at Tyler.

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