1. How the Macroeconomy Works - Circular Flow of Income Flashcards
What is the circular flow of income and what does it do?
Circular flow of income is a model of the economy – very simplified – which models for us how the economy works and grows etc.
What are the two key parts of the circular flow of income?
HouseholdsFirms
How do households and firms interact in the circular flow of income?
Housels provide FoP’s to firms in the form of labour and entrepreneurship and in return firms provide households with an income. Members of households then spend this income on products produced by firms this is their expenditure.
What are the categories within expenditure on the circular flow of income?
Government spending GSpending by firms – investment IExports XInjections
What are leakages of income in the circular flow of income?
Saving S Taxation TImports MLeakages
What happens when injections into the economy exceed leakages?
When G+I+X>S+T+M economy will growIf S+T+M> G+I+X economy will shrink/ a fall in growth
How else may the economy grow according to the circular flow of income?
Economy may grow if the number of households or the number of firms increases its making the whole flow bigger in itself.
What are the three ways we can measure the size of the circular flow of income?
We can measure the value of the goods and services produced - output method (real GDP)We can measure the total income of the households – income methodWe can measure the total expenditure of the households – expenditure method
How do we calculate the output method?
For this method we are measuring the value added through production, in other words you take into account the value of the raw material then consider the value added to this when the final product is sold. Don’t double count - include the value of raw materials + full value of final product.
How do we calculate the income method?
Add up all the incomes made in the economy.
How do we calculate the expenditure method?
You calculate the total expenditure in the economy – C+I +G + (X-M)
What is the relationship between the three methods?
All method will produce the same figure; Output = income = expenditureSo ‘real output’ is the same as ‘real income’ or ‘real expenditure’
What’s the difference between nominal and real incomes?
A nominal income is the figure or the physical amount of income, a real income is what that quantity can buy - real incomes are adjusted for inflation.
