1..5 National income and macroeconomic equilibrium Flashcards
What is the circular flow of income?
Homes receive factor incomes through earning wages and salaries from jobs and income from investments - buy goods and services supplied by firms
Businesses hire land, labour and capital inputs which they pay wages, dividends, interest, profits and rent
State collects taxes from households to fund spending on government services to households. They also collect taxes from firms
The circular model may also include imports from the rest of the world and then gain money from exports from the rest of the world
The financial sector may also be added as households put savings into the financial sector which goes into business investment for firms
What are the measures of income?
Original - jobs, pensions and interest
Gross - original income + benefits
Disposable income - minus taxes
Post tax - minus indirect taxes
Real income is adjusted for inflation
Distribution of income and wealth in UK
Average income of poorest 20% in the UK fell by 1.6%, growth of richest 20% grew 5%.
Richest 10% own 44% of wealth, poorest 50% own 9% of wealth
What are the injections and withdrawals?
Injections:
- Investment
- Exports
- Government spending
Withdrawals:
- Savings
- Imports
- Taxation
What is short run equilibrium?
Injections = leakages
Also when AD = AS
What are the causes and effects of a fall in SRAS
Causes:
- Brain drain - out migration
- Loss of capital investment spending - interest?
- Higher cost from volatile commodities
- Effects of natural disaster/conflict/war
- Depression/recession
- Ageing populations
Consequences:
- Inflation
- Reduce GDP growth
- Lower profit, investment and employment
- Worsen trade balance
What are the causes and effects of a fall in LRAS
Causes:
- Brain drain
- Decline in investment spending
- Higher production costs from commodity prices
- Effect of major natural disaster/conflict/war
Consequences:
- Cost push inflation
- Reduced real GDP growth
- Lower business profits, investment and employment
- Worsen trade balance because of decline in competitiveness
What is the multiplier effect?
A change in the components of AD lead to a multiplier change in equilibrium level - a change in injections lead to a more than proportional increase in real GDP
This occurs as the injections of new demand stimulates further spending - one’s spending is another’s income and so there is a larger final effect on national output
For example, a £200m government project may inject extra demand and output in the economy and businesses benefit, creates new incomes for construction workers which stay inside
What is the multiplier ratio?
Total change in GDP = injection x multiplier
The bigger the multiplier, the bigger the change in real GDP
What are the marginal propensities to _____?
Proportion of additional income spent on x:
MPC - additional income spent on consumption
MPM - additional income spent on imports
MPS - additional income saved
MPT - additional income paid to government
MPW - MPM + MPS + MPT - additional income withdrawn from the economy
Formula for the multiplier
1/MPW
Or 1/1-MPC
Note if it is a closed economy or have no government there may be no MPM/MPT
What is some evaluation for the multiplier?
- Will incomes stay within circular flow
- Is the multiplier strong?
- Difficult to measure multiplier as many factors in play at once
- Always a time lag
- Observed to be very low so not have as much power as suggested
How is the multiplier visually represented?
Assume for each £100 - 10% is saved, 20% is taxed, 20% is imported
MPS=0.1 MPM = 0.2 MPT = 0.2 - multiplier = 1/0.5 = 2
At each stage extra money flowing around gets smaller as money leaks out
From the £200m injection, £20m saved, £40m taxed, £40m imported
If £100m GDP is then created, £10m saved, £20m taxed, £20m imports
If £50m is generated form that then £5m saved, £10m taxed, £10m imported
Why may a country have a high/low multiplier?
High:
- lots of spare capacity to meet AD
- MPM and MPT low
- High MPC and extra income - low MPS
Low:
- Close to capacity limits - during boom
- Propensity to import and services is high - extra demand leaks from circular flow
- Higher inflation causes rising interest rates which dampens other components of AD
