When consumer spending decreases, it has a direct impact on the overall economy, potentially triggering a recession. We can illustrate this effect using both an Aggregate Demand and Aggregate Supply (AD-AS) diagram and a Phillips Curve diagram.
1. Aggregate Demand and Aggregate Supply Diagram
In the AD-AS model, we start with an initial long-run equilibrium where the Aggregate Demand (AD) curve intersects the Short-Run Aggregate Supply (SRAS) curve at the Long-Run Aggregate Supply (LRAS) curve. This point is labeled as ‘P’. A fall in consumer spending causes a leftward shift in the AD curve. This shift reflects a decrease in demand for goods and services, leading to a new equilibrium point at a lower level of output and employment, indicating a recession.
2. Phillips Curve Diagram
On the Phillips Curve, which illustrates the inverse relationship between inflation and unemployment, we also see effects from the fall in consumer spending. The initial point where inflation and unemployment are at their equilibrium is labeled on the curve. As consumer spending falls, unemployment begins to rise (due to reduced demand for goods and services), shifting us along the Phillips Curve to a point of higher unemployment and potentially lower inflation rates, representing the recessionary state.
Both diagrams visually capture the impact of decreased consumer spending, illustrating how it disrupts the economy and leads to a recession characterized by lower output and higher unemployment.