02 Circular Flow of Income and Macroeconomic Objectives

Question 1

Define the Circular Flow of Income.

Answer 1

Shows connections between different sectors of the economy. It revolves around flows of goods and services and factors of production between firms and households.

Question 2

What are injections?

Answer 2

Extra money placed into the circular flow of income.

Question 3

What are withdrawals?

Answer 3

Money taken out of the circular flow of income (also known as leakages)

Question 4

What are the 3 injections?

Answer 4

• Investment
• Exports
• Government spending

Question 5

What are the 3 withdrawals?

Answer 5

• Taxation
• Imports
• Saving

Question 6

When does macroeconomic equilibrium occur in the circular flow of income model?

Answer 6

If there is no pressure on national income to rise or to fall.

Question 7

When does national income increase?

Answer 7

I + G + X > S + T + M: When there are more injections

Question 8

When does national income decrease?

Answer 8

I + G + X < S + T +M: When there are more withdrawals

Question 9

When is there macroeconomic equilibrium?

Answer 9

I + G + X = S + T + M: When injections equal withdrawals

Question 10

What are the 3 ways to measure GDP?

Answer 10

• Output
• Income
• Expenditure
• Any of the 3 should theoretically give the same answer

Question 11

If withdrawals are greater than injections, the economy will…

Answer 11

suffer declining incomes, output and expenditure.

Question 12

Lower incomes will reduce the levels of…

Answer 12

taxation and saving, causing withdrawals to shrink until they equal injections.

Question 13

If injections are greater than withdrawals, the economy will…

Answer 13

expand.

Question 14

When the economy is growing, households and firms will pay…

Answer 14

more tax, and are also likely to save more.

Question 15

Define income.

Answer 15

A flow of money which acts as a reward for the services of factors of production.

Question 16

Define wealth.

Answer 16

The stock of assets held by an individual or organisation.

Question 17

Give examples of income.

Answer 17

• Wages
• State pension
• Dividends
• Interest

Question 18

Give examples of wealth.

Answer 18

• Shares
• Bank savings
• Gold
• House

Question 19

What is an example of gaining income from wealth?

Answer 19

Dividends from shares.

Question 20

What is an example of gaining wealth from income?

Answer 20

Those on high income can afford to build up their wealth over time by buying up shares.

Question 21

What is the link between income and wealth?

Answer 21

They have a positive correlation, meaning that citizens tend to either have high levels of income and wealth or low levels of income and wealth.

Question 22

What is the counter-argument to the idea that income and wealth have a positive correlation?

Answer 22

• It depends on how much income wealth is generating
• There may be a time lag
• Redistribution policies could reduce inequalities in income and wealth

Question 23

Define the multiplier effect.

Answer 23

When an initial change in injections/withdrawals to the circular flow of income leads to a greater final change in real GDP/national income.

Question 24

What is the Marginal Propensity to Consume? Give an example.

Answer 24

Measures the proportion of extra income that is spent on consumption - e.g., if an individual gains an extra £10, and spends £7.50, then the MPC will be 7.5/10 = 0.75

Question 25

How can the multiplier be calculated?

Answer 25

1/(1-MPC)

Question 26

If consumers spend 80p and save 20p of every £1 of extra income, the multiplier will be…

Answer 26

1/(1-0.8) = 1/0.2 = 5

Question 27

Changes in aggregate demand may lead to a…

Answer 27

greater change in national income.

Question 28

What is a closed economy?

Answer 28

When there is no government sector or trade - consumers can spend or save.

Question 29

If the Marginal Propensity to Consume is 0.9, then the Marginal Propensity to Save is…

Answer 29

0.1

Question 30

MPC + MPS =

Answer 30

1

Question 31

What is the evaluation to the Multiplier?

Answer 31

• Depends on withdrawals - multipliers would be reduced if consumers who benefit from them were to save their money, buy foreign imports with their money and if consumers and businesses have to spend money on T rather than S and I
• May take time for full effect of multiplier to come into effect - e.g., time for government support to see new firms set-up
• Hard to measure the exact effects of the multiplier which could make managing the economy more difficult

Question 32

What are the 4 main macroeconomic objectives?

Answer 32

1. High Economic Growth
2. Low and Stable Inflation = 2% CPI (+ or - 1%)
3. Reduction in Unemployment
4. A Balanced Balance of Payments (M and X)

Question 33

What other macroeconomics objectives are there, other than the main 4?

Answer 33

• A balanced budget (G and T)
• Make the distribution of income more equal
• Protection of the environment

Question 34

What policy tools can be used by the government to achieve its objectives?

Answer 34

• Fiscal Policy
• Monetary Policy
• Supply Side Policies