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COMPARATIVE ADVANTAGE: The ability to produced one good at a relatively lower opportunity cost than other goods. While pointy-headed economists developed this idea for nations, it's extremely important for people. A comparative advantage means that no matter how good (or bad) you are at producing stuff, there's always something that you're best (or least worst) at doing. Moreover, because you can produce this one thing by giving up less than what others give up, you can sell it or trade it to them. This idea of comparative advantage means that people and nations can benefit by specialization and exchange. You do what you do best, then trade to someone else for what they do best. Both sides in this trade get more and are thus better off after than before.

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On The Lookout For A RECESSION

One pitfall facing any pedestrian who explores the intricate details of the economy is large potholes lurking along the path. LOOK OUT! You can probably expect a few bumps and bruises from abruptly introducing your face to the pavement. But, after the cast hardens and the gashes have been stitched, you can be on your way. A little more experienced, no doubt, but forging ahead in spite of it all. Our economy also steps into an occasional pothole in route to an expanding economic pie. Recession is the nifty term we use for this sort of economic pothole and it will be are our topic for the next few pages. OH NO! LOOK OUT!

Making Acquaintance with Recessionary Potholes

As our economy moves along the unrepaired highway of life, we encounter a great deal of unevenness, much of which is inconsequential. We shake, we rattle, but we usually keep rolling. On occasion, however, we hit one doozy of a pothole. Our economy is thrown into a tailspin that lasts for a year or two. The first question we need to address is: How do we separate the economy's inconsequential shaking and rattling from an actual, bonafied, real-life recession? Or alternatively: What is a recession and how do we know when we're in one?

In principle, a recession is a general decline in economic activity -- a shrinking of our economic pie -- that lasts six months or more. There's nothing really magical about the six month time period other than it keeps the government-types from worrying too much about incidental shaking and rattling. Instead, they're able spend their time (and our tax dollars) dealing with leg-breaking, teeth-jarring potholes.

We usually know when we're in a recession by looking at real gross domestic product, the best measure of our economic pie that we have. When our pie shrinks, real gross domestic product goes down. Other measurements, however, can also tell us that we're in a recession. Some of the more common indicators are:

  • Unemployment rate. This is the percentage of people who would like to work, but who aren't working. When a recession hits, the unemployment rate goes up. When a recession is over, the unemployment rate goes down.

  • National or personal income. This is the amount of income earned from producing our economic pie. With less pie produced, and fewer workers working, there's less income.

  • Retail sales. As the name suggests, this is the amount of stuff that consumers buy from stores. During a recession, we aren't working and producing as much, have less income, and thus we buy less stuff from stores.

  • Government taxes. A recession also tends to see a decline in government tax receipts because we're getting less taxable income and buying fewer taxable goods.

I could continue this list, but you probably have a good idea that a lot of stuff in the economy shrinks in a recession. That's the idea behind the "general decline in economic activity." Like tripping over a pothole, our economy falls down during a recession, suffering a few bruises or breaking a minor bone, but we're usually able to get up and keep going.

The Short and the Long of It

While recessions get the headlines and publicity from the news media, they're only part of the ongoing economic process we term business cycles. Let's put it all in context by pondering the short-run and long-run of the economy.

  • In the long run, the size of the economic pie tends to expand with increases in the quantity and quality of the resources. You can find out more about this under the heading of economic growth. However, what we need to note here is that the ability of the economy to produce and supply consumer-satisfying stuff in the long run increases with economic growth.

  • In the short run, however, we may or may not buy all of the stuff that our economy is able to produce. This is where recessions enter the picture. If we, the buyers, don't buy everything our expansive economy can produce, then we have a recession. If, however, we try to buy too much -- more than our economy can produce -- then we end up with inflation.

As such, here's the picture: Our economy has a certain production ability based on the quantity and quality of our resources. We're always trying to make full use of that ability -- no more and no less. This is not an easy task. At some times, for reasons to be explored in a few paragraphs, we fall short of this ability, and a recession results. At other times, we overshoot our abilities, and we get higher rates of inflation. Up and down we go, always trying to match our production abilities, but frequently missing it in one way or another.

So What?

Newsguys, leaders of the first and second estates, and pointy-headed economists, all tend to be quite worried about recessions. Either they're fretting that one is about to begin, wringing their hands about when (or if) the current one will end, or blaming each other for one that just ended. Okay, what's so bad about recessions?

  • Unemployment. The first and biggest problem of a recession (especially for taxpaying, hard-working consumers of the third estate) is unemployment. When the economy takes a downturn, fewer resources -- especially labor -- are hired to produce stuff. A lot of people are thrown out of work for periods ranging from a few months to a year or more. A typical recession gives us 2-3 million unemployed workers, who have less income and thus either consume less or use up a lot of their savings. It's not a pretty picture.

  • A shrinking pie. Even if you're among the fortunate 90-plus percent of the labor force who escape the problems of unemployment, it doesn't mean you escape a recession entirely. When our economic pie shrinks there's less stuff for everyone. It also means that more of your tax dollars go toward helping the less fortunate through unemployment compensation, welfare, and even social security.

Although recessions have undeniable problems, there's some good to be found from lying face down on the pavement. Three sorts of good can come from a recession:

  • If our economy has been expanding rapidly for several years, a recession lets it pause to catch its breath. Recessions let workers and businesses take an involuntary, but often much needed, "vacation."

  • Recessions tend to weed the inefficient resources from an industry. The first workers to be laid off and the first businesses to close their doors are the least productive ones. Bad for them in the short run, but good for the economy in the long run.

  • In that most of us are basically creatures of habit, once we get into a job we're prone to remain there unless something extraordinary happens. Recessions and the resulting unemployment gives many workers that extraordinary something needed to find a better job.
Are Recessionary Potholes Inevitable?

While recessions, like potholes, seem to pop up every so often, are they avoidable? Is their any chance that we (that is, we as in government) could eliminate them through what are termed stabilization policies? To answer these questions -- and many more -- we need to get a firm grasp on why recessions occur.

Most of the pointy-header scholars who look into this sort of thing have come up with three possible explanations. We're not quite sure which one is THE answer, but more than likely they're all somewhat important.

  • National mood. If you buy into the idea that the economy needs to rest every so often, then it makes sense to think that everyone in the economy collectively grows tired from the pressures of an expanding economy. That is, businesses, consumers, and even the government say that we've done a lot of growing, let's stop for a rest. This is seen when consumers who have bought a lot -- furniture, houses, cars -- decide that they just don't need anything else. Or businesses that have done a great deal of investment, decide that they don't need any more capital. When we all stop buying, we produce less, and we get a recession.

  • Politics. The government has a lot of power over the economy. Those in control of the government can use this power for the wrong reasons -- to get re-elected. A number of economists say that the expanding and recessing economy is caused by politicians who spend heavily in one period -- before an election -- then cut back during another -- after the election. Spending a bunch here, then cutting back there, can trigger an expanding economy for a while then a recession later on.

  • Extracurricular events. It's also possible that a recession is the result of things that happen outside the confines of our economy -- things over which we have no control. For example, a natural disaster might decimate a large part of the economy and trigger a recession. Then as the economy rebuilds, it begins to recover from the recession. Wars, political revolutions, global trading conflicts are but a few of the extracurricular events that could cause our economy to rise and fall.
Looking Out for the Potholes

We've now come to the most important part of this recessionary business. How can you tell when a recession is on the horizon? The honest answer is that you can't. However, this hasn't stopped economists and others from trying. There are a few warning signs of an imminent recession that can be gathered from the newspapers and nightly newscasts. Keep in mind, though, that the signals they give are occasionally wrong.

  • Economic forecasts. As noted in the entry on economic forecasting many pointy-heads spend their working lives developing sophisticated mathematical models that allow them to forecast oncoming recessions. In general, these tend to be about as reliable as weather forecasts -- without the colorful maps. They aren't perfect, but they are better than flipping a coin.

  • Leading economic indicators. Our little discussion on economic statistics also notes a valuable set of government published data referred to as leading economic indicators. These are things like stock market prices and housing construction permits that tend to rise or fall a few months before the rest of the economy rises or falls. Unfortunately these aren't perfect either, as suggested by one economist who noted that they have predicted 10 of the last 7 recessions. (Think about it for a moment.)

Recessions are good for some of us and bad for others. While the government spends a lot of effort trying to control recessions and keep our economy on a straight and narrow path of growth, they seldom reach perfection. While you can't spend your entire economic life looking over your shoulder for the inevitable onset of a recession, there are a few things that you can do survive.


Recessionary Tips for the Nimble-footed Pedestrian

  • Don't panic. Even during the worst recessions of the last 50 years, 90 percent of the workforce and population has survived with little hardship.

  • Avoid recession-prone industries. The construction, automobile, furniture, and appliance industries all tend to be hardest hit during recessions. If you seem to get laid off when a recession hits every few years, then you might want to consider a new industry or career. Health care is one industry that tends to be recession "proof." Many others abound.

  • There are are areas that even expand during recessions. Education tends to be hot in recessions because laid off workers return to school. Bankruptcy lawyers are also in big demand during recessions, for obvious reasons. It might be worth the effort to search out those industries that do well during recessions.

  • Like recessions hit industries unevenly, they also hit some parts of the country harder than others. In fact, it's not uncommon for some states to boom during a national recession. If you're tired of frequent recessionary layoffs, then check out some states that tend to do well during the nationally bad times.

  • And last, it doesn't hurt to have a financial cushion, especially if you're stuck in a recession prone state or industry. Because states and industries that do the most declining during a recession also tend to do the most growing at other times, you might want to save a little extra during the good times to prepare for the inevitable recession.

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