Why Recessions Happen

The sky is falling. Everyone’s losing their job. The dollar isn’t worth what it used to be. Everything’s doom and gloom. Yet economists and politicians seem to insist that this is all part of a cycle, which includes recessions, booms, depressions, bull markets, bear markets, and other mumbo jumbo.

So why does the economy collapse every now and then? What makes it rise and fall? Why can’t we just have a booming economy forever? It all has to do with the inherent flaw in capitalism. Consider the following picture:

// There used to be a picture called: The Business Cycle

Assume there are two groups of people: business people, depicted by the Monopoly guy on the left, and customers, depicted by the Monopoly guy on the right. These people play multiple roles, too: business people are also employers, and customers are also employees.

In order to make a profit, a business person has to make more money than his expenses. One of his expenses is employees, so that means he needs to make more money than he pays his employees.

In order for employees/customers to save money, they have spend less than they earn.

Thus a business person has to make more money than he pays employees, and employees have to earn more than they spend. Since employees are customers, the money they spend is the revenue for the business person. So for an economy to be stable, business people and employees must make more money than one another, and the economy collapses.

Almost done for today. Economies are much more complex than a single business person and employee, so the relationships are not as apparent. Other things factor in as well.

Until next time

Joe