1.1 B - Circular flow of income Flashcards
What is the circular flow of income diagram?
on the outside
consumers –> buy goods and services –> producers
producers –> pay rewards to owners of factors of production–> consumer
On the inside
consumers –> provide factors of production –> producers
producers –> make goods and services –> consumers
Multiplier effect definition
A process by which every expenditure generates a tail of subsequent expenditure so that the resultant change will exceed the amount initially expected
What are the two types of economies?
- Closed economy
- Open economy
What is a closed economy
No interaction with foreign economic agents and economies
How does income work in a closed economy
Income circulates within the domestic economy
Dometic production == Dometic consumption
What is an open economy
Interactions between a domestic economy and the global economy
How does income work in an open economy
Income can be both injected and leaked out of a domestic economy over time
-need diagram
leakages
Describes the negative flows of income out of the circular flow of income
Injections
Positive flows into the circular flow of income
What are the leakages in economies around the world
- Taxes
- Savings
- Imports
These all == MONEY OUT
How is taxes an example of a leakage
Income tax is a level of income that individuals have rightly earnt from their labour that they cannot spend - therefore it’s a leakage because it cannot be spent on domestic G&S that are produced.
How is savings an example of a leakage
Consumers have a choice to spend or save, by saving means that G&S aren’t being consumed and the money is not circulated within the flow of income.
domestic consumption is sacrificed today in order to increase consumption in the future
How is imports an example of a leakage
Spending on foreign g&s means the money is going out of the domestic economies.
What are examples of injections
- Government spending
- Investments
- Exports
- MONEY IN
How is government spending an example of an injection
Government spending to improve infrastructure or to better quality of education, they have to inject money into firms - domestic producers.
How is investments an example of an injection
Business investment - increase the amount of capital they have or better technology, they have to invest back into the economy.
How are exports an example of an injection
Exports are selling domestically produced g&s to foreign consumers, so money back into the flow of income from foreign economies.
How does leakages and injections effect the overall circular flow of income
There won’t be a consistent level of income circulating in the open economy (high and low levels of income)
closed economy - consistent level of income
What are the trade flows that exist within an open economy
Domestic consumers buying goods and services from other countries
-> MONEY OUT
-> that leads to the countries use our money to buy our g&s (long-term)
–> MONEY BACK IN
long term view of this, these flows of income will balance out
What are the mutual benefits of trade flows in an open economy
ALL INCREASE:
-production
-specialisation
-access to capital
-economies of scale
-competition
What are the government flows (spending and taxation) within the circulatory flow of income
Taxes imposed by the government
-> MONEY OUT
–> use tax revenue to increase spending or make investments
—> MONEY BACK IN
in the long term this could lead to a far greater increase in income than what was taken out due to the multiplier effect being active
Finance sector (savings and investment) work as a pair - circulatory flow of income
Savings made by consumers
-> MONEY OUT
–>Savings provide funds for domestic investments (loans and borrowing)
—> MONEY BACK IN
Savings definition within the cirulatory flow of income
consumers save instead of spending leading to domestic consumption being sacrificed today in order to increase consumption in the future.
How is economic growth effected by injections and leakages
Injections > Leakages —> economic growth increases
Injections < Leakages —> economic growth decreases
Injections = Leakages —> economic growth stays the same
