2.4 Flashcards
Circular Flow of Income
An economic model showing the flow of goods and services, the factors of production and their payments between households and firms within an economy.
What assumptions does the circular flow of income make
- Households spend all their income on goods and services
- Firms spend all their income on factors of production
Wealth
Stock concept e.g. assets owned and human wealth such as education.
Income
Flow concept - money generated from wealth.
Injections
Money injected into the circular flow of income
- Government expenditure
- Investment
- Exports
Withdrawals / leakages
Money leaving the circular flow of income
- Savings
- Taxes
- Imports.
Macroeconomic equilibrium
When the demand side and supply side of the economy equal each other.
No excess demand or supply.
Everything produced in an economy is purchased by consumers.
What group of economists advocate improving AD in the long-run
Keynesian economists.
If the economy is operating below full potential. AD should be stimulated.
What group of economists advocate improving LRAS in the long-run
Classical economists.
They believe if AD is stimulated with no attention to LRAS (Improving FOP quality and Quantity) then inflation will occur and damage economic growth.
The multiplier formula
1 / MPW
OR
1 / (1 - MPC)
The multiplier effect
When an initial injection into the economy or circular flow of income causes a larger final increase in RNO/output
The marginal propensity to consume (MPC)
The proportion of a change in income (the margin) that will be spent on consumption rather than being saved.
What affects the MPW ( Marginal Propensity to withdraw)
- MPS (Save)
- MPT (Taxes)
- MPM (Imports)
MPS (Marginal Propensity to Save)
Proportion of extra income used to save.
If interest rates are higher, MPS will be higher
MPT (Marginal Propensity to Tax)
Proportion of extra income that is taxed.
If taxes are higher, the multiplier is lower. (more leakages)
MPM (Marginal Propensity to Import)
Proportion of extra income spent on on imports.
Higher imports reduces the multiplier. Caused by strong exchange rates making imports cheaper.
What is the multiplier determined
The size of leakages in an economy.
More leakages = lower multiplier.
How the economy effects the multiplier
- Little spare capacity means an increase in AD may not be met by firms
- Unemployment
- Inflation
- Exchange rates
What group is likely to have a higher MPC
Lower incomes.
AD will shift further so governments may target these for a higher multiplier.
