Let's look at what happened to the travel industry after the September 11 terrorist attacks.
- The plane hijackings shook a lot of people's confidence in air travel. It also made people extremely wary of densely populated areas, including big cities, theme parks and other popular tourist destinations.
- A huge number of travelers immediately cancelled their flights, and others decided not to go on any big trips. In other words, the demand for air travel plummeted. The demand for hotel rooms, travel agents and dozens of other travel-related services also shrank considerably overnight.
- Travel service producers were faced with a supply that far outweighed demand. The airline industry, for example, had way too many empty seats on its flights. To deal with this turn of events, travel producers had to reduce both the price and supply of their product. In the airline industry, this meant reducing ticket prices as well as cutting back on the number of flights.
- Reducing supply and price meant that the travel producers did not need to consume as much labor. Consequently, they had to lay off a lot of their workers.
- With a much smaller income, the laid-off airline workers had to reduce their spending. This reduced the demand for other products, contributing to cutbacks in other industries and setting off similar spirals.
- The employees who were not laid off were afraid they would be laid off, so they also reduced their spending.
- The travel producers reduced demand for the products they need. In the airline industry, for example, there was reduced demand for in-flight meals, airplane equipment and room-and-board for their traveling crews. In this way, the contracting of the airline industry affected a number of other industries.
- All of this was played out on the news, shaking the confidence of millions of workers who had nothing to do with the airline industry. They saw the struggling airlines as evidence that the economy was heading downhill in general. Afraid they would lose their jobs in the near future, they also cut back on spending, further reducing demand in hundreds of markets.
In a healthy economy, problems with the airline industry probably wouldn't affect as many companies or workers, and most of the workers it did affect would be able to move on to other industries. But with enough similar problems in different markets, these workers felt like they didn't have anywhere to go.
When producers and consumers see negative things happening in several different industries, they believe things will get worse in other industries in the immediate future. They stop consuming and producing as much, which causes things to get worse on a larger scale. In a shrinking economy, just as in an expanding economy, everybody is guessing what everybody else will do.
Different sectors of the economy are contracting all the time, and the economy as a whole may periodically contract, too. But economists only declare a recession when the economy is contracting as a whole for an extended period of time. In the next section, we'll see how economists make this determination.