There are many potential factors that can cause economic instability, and these factors include internal and external conditions. For example, the economy of the United States can be negatively affected by factors within this country as well as by factors in other countries. The economy of one country can significantly impact the economies of other countries.
Specific factors that can cause economic instability include stock market fluctuations, fluctuations in the prices of houses and other assets, black swan events, and changes in interest rates. The following sections describe these factors in more detail.
Stock Market Fluctuations
Stock market fluctuations, particularly stock market crashes, can lead to economic instability since crashes in the stock market can lead to decreased wealth and spending. Many people have money invested in the stock market, and crashes in the stock market mean they will lose significant amounts of money and wealth When people lose wealth, they are less likely to purchase goods and businesses will suffer.
Fluctuations in Price of House/Assets
Fluctuations in the prices of houses and other assets can lead to economic instability. One specific example of how the prices of houses can fluctuate is a ''housing bubble''. A housing bubble occurs when the values of houses increase significantly due to increased demand but low supply. When this occurs, more and more houses will be built to meet this increased demand. However, eventually, the demand for houses will decrease while the supply continues to increase which will lead to a significant drop in housing prices. This drip is housing prices is often known as the ''bubble bursting''.
When the prices of houses decrease significantly, some people will owe more money on their mortgage than what the house is worth. This can lead to some people defaulting on their home loans which will cause the banks that gave these loans to lose money. In 2008, the housing bubble burst which lead to many people foreclosing on their houses and banks and people losing significant amounts of money. These events eventually led to a recession.
Black Swan Events
Black swan events refer to large disasters that are unexpected and catastrophic. Black swan events include natural disasters (hurricanes, earthquakes) and widespread illnesses (COVID-19), and they can significantly impact the economy. For example, a hurricane that decimates a state or country will destroy houses and buildings leading to millions and millions of dollars in damage that will need to be paid. The wealth of people and businesses, production of goods and services, and spending will all significantly decrease.
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Interest Rate Changes
Interest has a large impact on the spending habits of people. When interest rates are low, people are more likely to buy more goods which will stimulate the economy. However, when interest rates are high, people are less likely to spend their hard-earned money, and the economy may suffer.
For example, interest rates on loans can impact the purchasing of homes. When interest rates are low, people are more likely to take out loans to purchase a house. However, when interest rates are high, people will be much less likely to take out these loans, and consumer spending will likely decrease.
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Economic instability can significantly affect a country and its population. Gross domestic product (GDP) refers to the total value of all goods produced by a country, and it is often used to measure the economic strength of a country. Economic instability can significantly decrease the GDP of a country which can impact the individuals living in the country.
The economic instability of a country will likely lead to people living in the country buying fewer goods. If people are buying fewer goods, businesses will likely produce less goods because of decreased demand. If businesses produce less goods, the GDP of the country will decrease.
Effects of Low-Income on Families
Economic instability has a significant impact on low-income families. Low-income families already often struggle with having enough money to buy basic living essentials such as food and shelter, and economic instability in their state or country can make their living situations even worse. When businesses reduce the hours of their employees or cut positions completely, it is often the lower-paid employees that are the most impacted. Low-income workers often do not have any savings to fall back on and they live paycheck to paycheck. A loss in wages can lead to the inability to pay for even the most basic needs.
There are many challenges low-income families face during periods of economic instability. Specific problems faced by low-income families include:
- Having enough money to pay for food, electricity, power, shelter
- Multiple families or generations living in the same place to help split the costs
- Frequent moving
- Parents working multiple jobs which can decrease the time they can spend with their families
- Inability to pay for childcare
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Specific examples that illustrate economic instability include:
- Great depression: The great depression was the result of the stock market crash of 1929. Before the crash, the economy was very strong, and the country's total wealth more than doubled during the 1920s. During this time, many people put a lot of their money into the stock market and businesses increased their production of goods. However, production eventually increased more than demand and many businesses were not able to sell their products. The stock market continued to rapidly increase while businesses could not keep up. Eventually, the stock market crashed in 1929 leading to the great depression.
- Recession of 2008: The housing bubble burst of 2008 led to a recession in the U.S. economy. When people were unable to pay their mortgages, banks started to lose money. This decreased banks' ability to lend money which led to a credit crisis.
- COVID-19: COVID-19 is a great example of a black swan event. COVID-19 forced many companies to shut down which led to many people losing their jobs. Spending on goods and services decreased significantly, and the economy suffered.
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The economy refers to the wealth and resources of a particular area, and it is dependent on the relationship between supply and demand. Economic stability occurs when the economy is strong and inflation and unemployment rates are low, consumer spending is high, average incomes increase, and businesses are thriving. Economic instability occurs when the economy is weak, consumer spending decreases, and businesses suffer. Inflation which occurs when the value of money decreases, and inflation and economic instability often go hand-in-hand. Causes of economic instability include stock market fluctuations, fluctuations in the prices of houses and other assets, black swan events (unexpected disasters that impact the economy), and changes in interest rates. A housing bubble occurs when the values of houses increase significantly due to increased demand but low supply. When this ''bubble bursts'', the prices of houses significantly decrease, and it can lead to economic instability.
Gross domestic product (GDP) is the total value of all goods produced by a country, and economic instability often causes the GDP of a country to decrease. Low-income families are often hit hard during economic instability, and during these times, they can have difficult times buying basic needs such as food and shelter. Specific examples of economic instability include the great depression of 1929, the recession of 2008, and COVID-19.
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Video Transcript
Definition of Economic Instability
A healthy economy is characterized by growth, stability in prices, a high employment rate, and the confidence of consumers. Businesses can be competitive and do not suffer from the effects of huge monopolies, and average household incomes are enough to meet the needs of citizens. Most people can even afford a few luxuries. However, when an economy becomes unstable, prices go up, consumers lose confidence, and people start to struggle just to get by. What can cause this to happen?
First, we need to define terms. An economy is defined as the resources and wealth of a country or nation as reflected by the production and consumption of goods and services. The economy of a nation does not exist in isolation. A national economy interacts with other world economies as nations exchange goods to meet the needs of their citizens. It also responds to natural events like hurricanes and earthquakes as well as political upheavals that affect international commerce.
Economic instability then occurs when the factors that influence an economy are out of balance. When an economy becomes unstable, there is inflation, which is a decrease in the value of money. This leads to higher prices, higher unemployment rates, and general angst among consumers and businesses that are trying to survive financially. In other words, people are not happy. They no longer invest and they cannot afford to buy much, either. This causes the economy to slow down even more.
Causes of Economic Instability
We could think of the economy as a human patient who requires certain conditions in order to remain healthy and strong. If the patient is stabbed with a knife, he will experience bleeding that makes him weak and puts him in danger. If he is not given nutritious food, he begins to starve. Like the patient, an economy responds to changes in its internal or external conditions. Some of these changes that can negatively affect and destabilize an economy include:
Stock Market Fluctuations
When the share prices of stocks in the stock market fall suddenly or sharply, this can affect the confidence of consumers, causing instability in the economy. People may invest less, sell their stocks, and buy less.
Fall in Home Prices
When the prices of homes fall, people may end up owing more on their mortgage loan than the house is worth because of the decrease in value. They may default on the loans and may also begin spending less. Banks lose money, and the economy becomes unstable.
Interest Rate Changes
Governments sometimes use interest rates through the Federal Reserve central bank to control inflation. When the inflation rate is increased, it costs the average person more to borrow money, so spending decreases, and then prices drop. This slows down inflation.
Black Swan Events
A black swan event is an event that is totally unexpected but that can greatly affect the economy. An example of a black swan event is a major hurricane or a large terrorist attack on the country.
Examples of Economic Instability
There are many examples of events that resulted in extensive economic instability throughout U.S. history. Often, the destabilization of the U.S. economy also affected the economies of many other large industrial countries of the world.
1. The Stock Market Crash of 1929
The well-known stock market crash of 1929 that led to the Great Depression of the 1930s was caused by a number of factors. Prior to this crash, the economy was strong, and people borrowed a lot of money and got into debt. They bought shares of stock on the margin, which meant they only paid for a small portion of the stock's value up front. Production of goods also increased more quickly than could consumption, and companies like auto manufacturers had trouble selling all their cars. When the market finally crashed in 1929, the gross domestic product (GDP), which is a measure of economic growth that represents all production within a national border, began to shrink drastically. By 1933, the U.S. was producing only about half of what it produced in 1929, and unemployment was at a rate of 25%, the highest ever recorded. Nearly fifteen million people did not have a job.
2. The Burst of the Housing Bubble
The financial crisis that occurred in 2007 through 2009 was in the making for years before it actually began. Then, as the market began to crash, terms that many people did not understand began to be tossed around while people watched their investments shrink. There had been a housing bubble, which means that the prices of homes went up drastically during a time when the supply of them was limited. Eventually, the supply increased and the demand for these homes dropped, causing the ''bubble to burst.'' Some of this bubble phenomenon was also caused by the prevalence of subprime mortgages, which are home loans that are given to people with poor credit. When people began to default on these loans, banks were left with the homes, which were then worth less as home prices decreased.
3. COVID-19
The COVID-19 pandemic of 2019 through 2021 is a black swan event that has had an enormous effect on both the U.S. and world economy. Because of the contagiousness of the COVID-19 virus, lockdowns have taken place, businesses have closed, and unemployment has increased. Tourism has rapidly declined and the future plans of many for new careers and employment have been postponed. Thousands of people have died and healthcare systems are overwhelmed. Supply chains of goods and products have also slowed, and the daily news reports show us the staggering economic results of this continuing event.
Lesson Summary
All right, let's now take a moment or two to review. As we learned, an economy is defined as a country's total resources and wealth as reflected in its production and consumption. Economic instability occurs when the factors that influence an economy are out of balance. Unstable economies are often characterized by inflation, which is a decrease in the value of money.
Economic instability is caused by changes in the conditions that kept the economy stable. Some of these include:
- Stock market fluctuations
- Fall in home prices
- Interest rate changes
- Black swan events, which are totally unexpected events that can greatly affect the economy, like a natural disaster or terrorist attack
There are many examples of times in U.S. history during which economic instability was rampant. During the stock market crash of 1929, which led to the Great Depression, the gross domestic product (GDP), which is a measure of economic growth that represents all production within a national border, shrunk drastically. The gross domestic product is a measure of economic growth that represents all of a nation's production and consumption of goods.
Other times of great economic instability were the burst of the housing bubble of 2007 to 2009 and the COVID-19 pandemic which began in 2019. In a housing bubble, the prices of homes rises drastically while supply remains low. When this occurs and when many people get subprime mortgage loans, which are loans given to those with poor credit, this can be a recipe for an economic disaster.
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