Common Mistakes in Economics

1.Rising House prices cause falling demand.

This is a little tricky because if we take an ordinary demand curve, an increase in the price will cause lower demand, there is a movement along the demand curve and so less is bought.

However the problem here is that rising house prices are invariably caused by rising demand. Therefore, it is incorrect to say that rising house prices cause a fall in demand. Rather what happens is that rising demand for housing causes the price to rise.

2. Bad Things Must Cause a recession

It is tempting to look at many economic mistakes and assume that these must be the cause of a recession. For example, the US has a huge national debt, current account deficit and has wasted billions of pounds on the Iraq War. Although these can be seen as economic problems. On their own they do not cause a recession. In fact government spending on a war can often cause a higher rate of economic growth. See: Iraq War and Recession

3. Inflation Causes a Fall in demand.

This is a similar mistake to rising house prices. Periods of high inflation do not cause Aggregate Demand to fall immediately. Again higher inflation is invariably caused by rising Demand in the Economy. However, periods of high inflation can lead to periods of recession. The reason is that:

  1. To reduce high inflation monetary authorities increase interest rates, this reduces demand and inflationary pressure.
  2. The inflationary boom is unsustainable and  therefore causes a boom and bust economic cycle. E.g. the Lawson boom and the recession of 1991.

See also: 7 Common Economic Fallacies