framework understanding what happens during a recession

During a Recession, or Depression, it seems as though suddenly the economic output drops and many people are out of work. But what causes this, exactly? Why would economic output drop and why would people not be able to work? This is something not well understood by economic thought, and we need a better framework to understand what's going on. A framework is an oversimplified model that can give you a visual idea what the problem is.

Thanks to God, I believe I have an economic model that can describe what's happening. (a little nod to King Solomon here)

There is something called 2 system meta-stability, where 2 different modes are the most stable points in a system. Each mode has it's own feedback effect, so the system tends to stay in one mode for a while, and then, eventually, some factor accumulates to the point where it gets pushed into the other mode and stays there. An example of this is periods of warm and cold in the earth's climatic history. If you try to graph these patterns long term (similar to what they do studying chaos theory) you'll see two separate shapes differentiate, with only a couple of stray lines connecting the shapes (each of these lines crossing over representing a transition event between the two modes). What would be the feedback effect in an economic downturn? Mainly increased competition. As consumption falls, businesses are competing with each other, lowering prices downward, actually taking a net loss. This will continue until some of the businesses go under, relieving the excess competition in the market. When the economy has been pushed into its alternate mode, it can no longer sustain all these businesses. Large parts of the economy become superfluous.

In a normal economy you might have four people all engaging in economic exchange with each other. But during a Recession, suddenly consumption reduces. Instead of needing four people to do jobs, only two are needed.

There's a couple of assumptions that need to be made in this model.

So what happens? Basically the other two people who are out of work continue to buy the services of the other two people until all their money has been drained. That leaves only two people engaging in economic exchange. Now, obviously at this point those two out of work people will begin selling their own services at a scant price level (only a small fraction compared to the amount of money being exchanged before). This will facilitate economic exchange, because the amount will be so small that it won't be considered worth the effort of the other two successful people. So as you can see, the model does eventually return to economic equilibrium and it seems everyone employed, so what's the problem then?

Well, one of the biggest problems I see is that large businesses are too bulky and unwieldy to adjust, and these large businesses are very important to most of the economic output in the economic system. For the individuals who have been excluded from participation in the economic system, new businesses can take form and deal at lower price levels. But these are typically going to be small businesses. Small business is much more nimble and more easily adjusts in the economy. For a larger business, dealing with lower price point economic exchange may simply not be worth the effort for them. Small businesses are, however, constrained to a large degree, by the domination of certain types of services offered by large businesses. An example might be the electric provider, or the owner of the strip mall the business is renting.

When consumption (people buying things) suddenly falls off, that has a natural tendency to magnify inequality. Think about the world of professional sports. Why does one player who is 10 percent better than another player get a million dollar contract while the other player (still very skilled) apparently isn't good enough to be able to make a living playing sports? Obviously competition can lead to disparate outcomes. And in an economy where there aren't enough jobs, those who aren't quite as good at competing are going to find they're left standing when several chairs have been pulled out and the game of musical chairs comes to an end. Not that there is necessarily anything wrong with these people.

One path I can see that may be able to help combat this would be creating more economic self-reliance (particularly on the individual level). But we all know that self-reliance doesn't have the same level of economic efficiency as specialized economic exchange, so that's only a partial solution.

So all these unemployed people could get together and start their own businesses, at least theoretically. Working at lower price levels, it wouldn't be worth it for more successful businesses to try to enter this "lower tier" market of economic exchange. (This of course assumes these unemployed have the capital to maintain and start a business, another whole issue)

This model can explain, for instance, why a construction worker, who builds houses for a living, could be able lose his own house during a Recession. That the very service you seek to provide to the economic system, you might not be able to get.

The last thing I want to say is that Recessions are almost always preceded by large levels of debt, and often by unsustainable systems (only people weren't able to recognize them as such).

 

I think you're onto something. If you're interested in this sort of thing, you might want to check out Austrian business cycle theory (https://en.wikipedia.org/wiki/Austrian_business_cycle_theory), which offers an explanation of why the boom/bust cycle occurs.

 

there is no business cycle, there is a cycle of govt interference that causes recessions. A recession then is the time it takes for an economy to recover from govt interference. FDR's Depression for example lasted 16 years because of continued govt interference. It ended only because FDR finally died!!

 

Lol, another thing you know nothing at all about.

 

In other words, when people stop spending out of fear of the future, a recession or depression is the result.

 

That's not really what I said.

Spending could drop for all sorts of reasons. Perhaps the prior level of spending wasn't really sustainable.
But anyway, I think some insights into the causes behind business cycles can be gleaned from chaos theory.

Look, when times are good, people tend to do things that cause a feedback effect to keep things good, but people also tend to do other things that, as they gradually accumulate, will eventually tip the scales into the other direction, that leads to bad times. The positive feedback is a shorter-term and more immediate effect. The negative feedback takes a bit longer to manifest, but as its results accumulate it eventually overcomes the positive feedback.

Let me give you an example of one whacky theory of 2 system meta-stability I saw propounded by someone in the Abortion forum. When the country is pro-life, the pro-choice population starts having a higher birth rate and eventually the country gets a majority that is pro-choice. Then the legislation and social mores start changing and the pro-choice population starts aborting most of their offspring again, and the pro-life side eventually takes over. So the country would continuously switch between 2 modes, each one lasting 20-25 years or so.

 

Animal spirits!

 

An explanation for why resource-rich countries are so often poor:

Essentially, if a country’s wealth is from natural resources, only a few people are needed to produce it The ruler does not have to care about the bulk of the population in the slightest. He simply divvies up all the money amongst his key supporters (ie the army and police) and all is good.

If by some chance the bad ruler is replaced by a good one, who wants to help the people. Well, that means less money for the said army and police, who are now strongly incentivised to replace the good ruler with another bad one who doesn't care about the people and will give them more money. So it's not just that the ruler does not have to care about the bulk of the population, it's actually in the ruler's interests to not care about the bulk of the population. As every $local_currency_unit spent on the population, is one not spent on the people who matter - i.e. the army and police.

In resource-poor countries, all wealth comes from the people - the workers, business owners, entrepreneurs and so on. There is an incentive for the ruler to look after them in the form of health-care, education, the rule of law and so on. An incentive which simply does not exist in a country where the wealth comes out of the ground.

 

Don't pretend you're adding anything. The notion of the dutch disease is well understood in economics.

If you want to be an economist, off you pop and write something for a journal!

 

Psychology

 

Yep! And the behaviouralists have done wonders in adding more detail, particularly in how erratic markets and economic crisis develop.

 

I'm saying in this thread that you don't necessarily need "Psychology" as an explanation for how erratic markets can exist.

 

You want to ignore human nature in order to make theoretical claim? Crikey, just a shame you won't born before the neoclassicalists filled that research agenda.

 

No, it's just my framework I'm proposing doesn't put primary focus on human nature, not in the way you're describing.

What you are talking about is something entirely different.

 

I'm referring to realism. You're attempting to chest puff, but you've missed the boat.

 

The below is mistaken??? Can the liberal say why???

there is no business cycle, there is a cycle of govt interference that causes recessions. A recession then is the time it takes for an economy to recover from govt interference. FDR's Depression for example lasted 16 years because of continued govt interference. It ended only because FDR finally died!!

 

No, no, no.
I know what you guys are talking about. This is something often taught in introductory macroeconomics courses as the reason economies enter recessions.
But what if it's not really true? I mean, on the surface it seems like a potential explanation for why a recession could happen, but what if it's not the real primary reason?
I'm thinking this explanation could be distracting economists from other deeper issues.

Just think about it, it doesn't even make much sense when you view it in a larger context. People get scared so they spend less money, then people lose their jobs? If you're viewing the same group as both consumer and spender, how can an individual stop producing because he is afraid of paying himself? Some of you might have difficulty wrapping your brains around that statement. Look, what basically "should" happen in this situation is that people will start being willing to work for lower prices as everyone is trying to spend as little money as possible. Your explanation wouldn't really result in much job losses (other than structural economic shift as the type of consumption changed, but that would be temporary).

To help you visualize this, imagine doing away with the money and imagine two people bartering their services. As you can see, "animal spirits" are not possible in this scenario.

To reiterate, basically what you're saying is "Psychology" as an explanation for all this and ignore everything else.
A potential explanation does not mean it's the true explanation (or the main explanation).​

 

A lot of words to say naff all! Its just painfully obvious that economic psychology needs to be embedded within the economic modelling. We don't need to rely on Keynes and animal spirits to recognise that. We can go back to the classical economists and their rejection of hyper-rationality. Of little surprise is the increasing import of Behavioural Economics and Behavioural Finance. Without the application of these methods, economics struggles to explain the likes of pricing bubbles and economic shocks inconsistent with marginalism.

 

why doubt it? people spend less when scared, then their wages go down because people are spending less, and then production goes down and we have a recession.

 

Economics is psychology. It's the study of human behaviour.
To take psychology out of economics is to render the subject useless. (Even more useless).

@Kaz nothing much to argue with here. All staple economic theories.

I go with life blooms. Boom and bust. Boom and bust. Boom and bust.
Basic "economic" cycle found in all life forms.

 

no, psychology is psychology. economics is mostly about production distribution consumption of goods and money.

 

Economics is a behavioural science. Same as psychology.

Supply and demand is psychology every bit as much as it is economics

Economics is not about "production consumption of goods and money".
It is how humans behave in regards to these things.

What makes a person buy a product?
What governs that decision? Psychology and economics both.

Stimulus, cheap available goods. Response, preferred purchase.

 

Agreed. Economics is a social science.

 

absurd, try to tell your Economics dept you want your BS Economics degree switched to BS in psychology. Course work is totally different. They would laugh

 

Economics is the study of how people allocate scare resources among competing ends over time.

It's a social science. It is concerned with how people act.