Influences of Economic Slowdown

Introduction

Economic slowdown, also know as recession, is a common term we come across in the news. This paper discusses the effects of the economic slowdown to the economy in general. The question posted does not indicate the cause of the economic slowdown and hence no assumption is made to the primary cause of the economic downturn.

Economic slowdown which is part of a business cycle is inherent in market economies. It has significant effects on the livelihood of the citizens and businesses performance of a country. The hypothetical business cycle with varying duration and intensity has four phases of peak, recession, trough and recovery as shown below (Tucker 2005, p. 390).

Figure 1. Hypothetical business cycle

Source: http://swlearning.com/economics/tucker/eft4e/ppt_exhibit/business_cycles.ppt

Economic slowdown occurs during the Recession stage shown above with the real GDP declining and reaches its lowest at the Trough stage. At this stage of the business cycle unemployment rises, business profits drops, and production capacity is underutilized. Generally a recession is period of at least two consecutive quarters where the real GDP declines heading towards a Trough (Guell 2007, p. 79).

This paper shall discuss how a country's economy is measured and the effects of the economic slowdown from the aspects of aggregate demand and supply, production capacity, inflation, employment rates and other inputs or outputs in relation to the economy. We shall also discuss how the government can attempt to react to the economic downturn through its fiscal or monetary policies quoting examples from previous economic downturns around the world.

Measurement of the Economy

The economic performance of a country is typically measured though it's Gross Domestic Product (GDP) which is the market value of all final goods and services produced during a period of time, usually a year (Tucker 2005, p. 363).

However, since the price and output of the goods and services changes from year to year, it does not give a meaningful comparison of the economic performance change. Real GDP provides a better measurement of the economic performance where the value of all final goods and services produced during the given time period is based on prices existing in a selected base year (Tucker 2005, p. 379). For example the Department of Statistics Malaysia (n.d.) uses 1987 as the base year for Malaysia's economic reports while the Bureau of Economic Analysis (n.d.) of the U.S. Department of Commerce currently uses the year 2000.

But how does the Department of Statistics or Bureau of Economic Analysis measure GDP? There are two approaches; namely the Expenditure Approach and the Income Approach. According to Tucker (2005 p. 366) the Expenditure Approach measures GDP by adding all the spending of final goods during the period of time which consist of personal consumption (C), government spending (G), gross domestic investment (I) and net exports (X - M). Of course these spending are adjusted accordingly for real GDP values. Accordingly, GDP is usually expresses by the formula below.

GDP = C + G + I + (X - M)

The Income Approach calculates GDP by adding all the income earned by households in exchange for the factors of production in the period of time (Tucker 2005, p. 370). These consist of compensation of employees, rents, profits, net interest, indirect business taxes and depreciation of capital.

According to Mankiw (2004 p. 205), both of these approaches should arrive to the same value of real GDP of the country for the period.

Economic Indicators

During the briefing mentioned in the question, what indicators gave the expectation that an economic slowdown was imminent? According to Tucker (2004 p. 394), leading indicators reflected in Table 1 below are variables that change before real GDP changes. Perhaps it was glaring enough to the audience of the briefing that some of these indicators are pointing towards an economic downturn.

Business Cycle Leading Indicators

Average workweek New building permits

Unemployment claims Stock prices

New consumer goods orders Money supply

Delayed deliveries Interest rates

New orders for plant and equipment Consumer expectations

Table 1

Source: Tucker 2004, p. 396

For example, the US government publishes some these economic indicators at www.economicindicators.gov while the Malaysian government provides them at www.statistics.gov.my.

Aggregate Demand and Supply

According to Tucker (2005 p. 481) the aggregate demand of the country's economy is reflected by the consumption of households, businesses, government and foreigners at different price levels during a time period, ceteris paribus. The aggregate supply reflects the level of real GDP produced at different possible price levels during the same time period, ceteris paribus (Tucker 2004, p. 484).

The aggregate supply and demand curves over short and long run are shown in Figure 2 below. The figure reflects the three ranges of the supply curve AS where E is the equilibrium at full employment.

Figure 2 - The aggregate demand and supply model

Source: Tucker 2004, p. 491

Effects of Economic Slowdown

An economic slowdown would be reflected by a leftward shift of the aggregate demand curve AD1 to AD2 to AD3 as shown in Figure 3. This will result in lower real GDP reflected by the decrease from Y1 to Y2.

To the man on the street, this decrease in GDP can be felt in various forms such as lower real income, lower consumer spending, lower consumer confidence, increase in unemployment and crime rates, businesses closing down and many other indicators which will be elaborated later.