Explain the term 'recession' and analyse two possible causes of a recession.

A recession is the phase of the economic cycle, after a boom, during which real GDP starts to fall and unemployment starts to rise. It is two successive quarters of negative economic growth. The UK's 'Great Recession' occurred over 6 quarters between 2008 and 2009 during which GDP fell by a total of 7.2%.

One possible cause of a recession is the collapse of a speculative bubble. For example, the collapse of a housing bubble causing a negative wealth effect, which leads to a fall in consumer expenditure and increased savings ratio. As consumption is a component worth approximately 60% of total aggregate demand, a sigificant drop over a 6 month period will cause a recession.

Another possible cause of a recession is a supply-side shock. This kind of shock is usually external, for example a rise in the price of imported oil. A rise in the price of oil would lead to in increase in production costs for firms (due to oil's widespread use in production and low price elasticity of demand). In turn, this higher cost is passed onto the consumers in the form of higher retail prices. This is known as cost-push inflation, which leads to a fall in real output, and a fall in consumption (according to the Keynsian Consumption Function). The combination in the fall in aggregate deamnd and aggregate supply will almost definitely reduce real GDP for at least 2 quarters.