If households and firms cut back on spending because they expect other households and firms to do so, and this self-fulfilling prophecy causes a recession, then this would be an example of:
A) Insider-outsider relationships
B) Efficiency wage theory
C) A coordination failure
D) A price-level surprise

Question

Quizplus · Accepted Answer

A coordination failure occurs when households and firms collectively make decisions that are individually rational but lead to an inefficient outcome for the economy as a whole. In this case, if everyone cuts back on spending due to the expectation that others will do the same, it can lead to a recession due to the decline in aggregate demand. This is a type of coordination failure known as a self-fulfilling prophecy. Insider-outsider relationships refer to the unequal treatment of workers in a labor market, efficiency wage theory explains why firms may pay wages above equilibrium to boost worker productivity, and a price-level surprise refers to unanticipated changes in the overall price level.

If Households and Firms Cut Back on Spending Because They