2.1 Measures of Economic performance Flashcards
What two components make up the circular flow of income?
Firms and households
How does the circular flow of income work
Firms produce goods and services (making up national output)
The households produce the labor, land and capital that firms use to produce the national output the money paid into the households is called national income
Households spend their income that firms create (known as national expenditure) and the flow repeats
What can affect the circular flow of income?
Injections and withdrawals (Leakages)
What are examples of injections into the circular flow of income?
Exports
investment
government spending
What are examples of withdrawals of the circular flow of income?
Taxes
Imports
savings
What happens when injections are greater than withdrawals?
Firms increase output which will lead to increased income and expenditure
What happens when withdrawals are greater than injections?
Firms will reduce output leading to decreased spending and incomes
What does the circular flow of income suggest?
As households keep spending, and firms keep producing then national output and income will not change
When an injection is made into the circular flow, how big is the income gained from it?
The change in national income will be greater than the initial injection - known as the multiplier effect.
What is the multiplier effect?
When the fiscal multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.
What is the multiplier effect?
When the fiscal multiplier effect occurs when an initial injection into the economy causes a bigger final increase in national income.
How do you calculate the multiplier effect?
Multiplier = Change in real GDP / Change in injections
or 1 / MPW
What factors affect the size of the multiplier?
- if people spend a high % of any extra income (a high mpc), then there will be a big multiplier effect. However, if any extra money is withdrawn from the circular flow the multiplier effect will be
very small. - Marginal Propensity to Consume (mpc). This is a persons willingness to spend money – if a worker saved all his money there wouldn’t be an increase in GDP
- Marginal Propensity to Withdraw (mpw). This is when money is withdrawn from the circular flow it includes mpt + mpm + mps
- The Marginal Propensity to Tax (mpt)
- The Marginal Propensity to Import (mpm)
- The Marginal Propensity to save (mps)
what is the definition of wealth?
The value of all asset owned by an individual or firms in an economy - it can either be physical money or assets.
What is aggregate demand?
Aggregate demand is the total demand for goods and services produced within the economy over a period of time.
What is the equation for aggregate demand?
C + I + G + (X - M)
Consumption + investment + government spending + (exports - Imports)
How does a rise in price affect AD?
Causes a contraction in AD
How does a fall in price affect AD?
Causes an expansion of demand
What does an outward shift in demand mean?
National output has increased
What does an inward shift in demand mean?
National output has been reduced
What factors lead to a fall in AD?
Fall in exports a cut in government spending Higher interest rates Decline in household wealth Increase in taxation reduced consumer spending
What can lead to an increase in AD?
Depreciation of exchange rate Cuts in taxation Increase in house prices Lower interest rates increased consumer confidence Increased value of exports increased government spending
What are the monetary policies that can be used to alter AD?
Interest rates
Supply of money
changes in the exchange rate
What are types of fiscal policy that can be used to alter AD?
Taxation changes
Government spending
Government borrowing
How do external shocks affect AD?
They can change demand suddenly, reduce output and affect employment
What are examples of external shocks?
A fall in the exchange rate
A recession in a key trading partners economy
A slump in housing and construction
Global financial events
A large change in commodity prices like oil
weather events
war/conflict that affects global trade and supply