Final answer:
Prices need to fall during a recession to help the economy reach a new equilibrium and restore full employment. Sticky prices and wages can prolong unemployment and recession because they prevent adjustments to the decreased demand for goods and services.
Step-by-step explanation:
During a recession, prices need to fall for several reasons tied to economic equilibrium and the restoration of full employment. When a recession occurs due to a drop in demand for goods and services, prices and wages that are sticky — meaning they do not adjust downward quickly to reflect the decrease in demand — can lead to increased unemployment and intensify the recession. If prices and wages remain high while demand is low, businesses may be unable to sell their goods and services, leading to a reduction in production and consequently, an increase in unemployment.
Conversely, if prices and wages can adjust downward, this can help the economy reach a new equilibrium at which point businesses can sell their products at lower prices, leading to an increase in the quantity demanded, which can then potentially lead to more hiring and a reduction in unemployment. The macroeconomic frameworks suggest that this adjustment helps stabilize the economy by aligning production with demand.
When inflation is low or turns negative (deflation) in times such as the recession of 1920-1921, the Great Depression, or the Great Recession of 2008-2009, it suggests that the price adjustment process is not working quickly or efficiently enough to end the recession promptly.