2.4 National Income Flashcards
Draw the Basic Circular Flow of Income
What is an injection into the Circular Flow of Income
extra spending put into the circular flow model
What are the 3 types of injections into the Circular Flow of Income Model
- Investment
- Exports of goods and services
- Government spending
What is a leakage of income into the Circular Flow of Model
- Saving
- Imports of goods and services
- Taxation
What is National Income
National income measures the monetary value of the flow of output of goods and services produced in an economy over a period of time (usually one year)
What are the key uses of measuring National Income
- The rate of economic growth (real GDP)
- Changes to living standards (real GDP per capita)
- Changes to the distribution of income between groups within the population
What is GDP
measures the total value of national output produced in a given time period (i.e. one year)
What are the 3 ways that GDP calculated
- Expenditure
- Factor Incomes
- Value of Output
How do you calculate GDP with expenditure
C + G + I + Change in Value of Stocks + (X-M) = GDP (AD)
How do you calculate GDP with factor incomes
- Income for people in jobs/self-employment
- Profits of public/private sector
- Rental income for land ownership
How do you calculate GDP with value of outputs
- Value added from each of the main economic sectors:
- Primary
- Construction
- Manufacturing
- Tertiary
- Quaternary
Value added = Value of Production - Value of intermediate inputs
What are some low value added industries
- Textiles
- Mass processed foods
- Farming
What are high value added industries
- Information technology
- Precision engineering
- Aerospace
Let the nominal (or money) value of UK GDP in 2015 be £1,400 bn
The price index for 2015 is 100
In 2016, the nominal value of GDP rises to £1450 bn
In 2016, price index rises to 103
what is real gdp in 2016
= Nominal GDP x 100/price index in 2015 = £1,450 bn x 100/103
Real GDP = £1,408bn
(expressed at constant 2015 prices)
How does the balance of the injections and withdrawals contribute to growth of the economy
If the sum of injections is greater than the sum of leakages/withdrawals, then the economy will be growing
whilst if injections are smaller than withdrawals, it will be shrinking.
In an equilibrium, injections must be equal to withdrawals and so the national income remains the same.
What matters in terms of AD shifts and macroeconomics equilibrium
What matters is whether total planned demand for goods and services (AD) is close to actual production from domestic and external sources.
What is the effect of an outward shift in AD
An outward shift of aggregate demand will bring about a cyclical rise in output and employment.
What is the effect of an outward shift in AD
An outward shift of aggregate demand will bring about a cyclical rise in output and employment.
What is the impact of an increase in AS
An outward shift of aggregate supply e.g. caused by lower unit costs should help to increase business profits.
What are the causes of an inward shift of LRAS
- natural disasters such as drought.
- Loss of factor inputs caused by forms of political conflict
- Large scale net outward labour migration (brain drain)
- A trend decline in productivity caused by a persistent recession
What is the effect of increasing investment
- Increasing in demand for capital goods
- A boost to AD and also AS
What are macro effects of a fall in AS
**Possible Macro Consequences
**
* May cause higher inflation
- May reduce real GDP growth
- May lead to lower profits, investment and employment
- May worsen the trade balance
What is the liquidity trap
after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rather than holding a debt which yields so low a rate of interest.
Explain the movement from Point A –> B–> C
Shift of AD1 to AD2. In the short tun this will result in a movement up the
SRAS curve, output will rise from OY1 to OY2 and accompanied by a small rise
In the price level from OP1 to OP2. Moving the economy from A to B
The economy is now in long run disequilibrium. The full employment level is OY1. The economy is therefore operating at over-full employment. Firms will find it difficult to recruit labour, buy raw materials and find new offices/ factory space. Firms respond by bidding up wages
The SRAS curve is drawn on the assumption that wage rates and other costs remain constant so a rise in wage rates will shift upwards and the short run equilibrium will now fall and price will keep rising
The economy will now fall and keep rising. The economy will only return to long run equilibrium when the short tun aggregate supply curve has shifted upwards so that AD once again equals LRAS at C
Explain the movement from A –> C using investment expenditure
- An increase in the investment will increase the capital stock of the economy will initially shift the AD curve to the right from AD1 to AD2
- There will then be a movement along the SRAS curve from A to B, there is now long-run disequilibrium
- When solved, the LRAS curve will then shift to the right from LRAS1 to LRAS2
- Long run equilibrium to be restored to C, there will also be a new SRAS curve because it is assumed that investment has reduced costs of production
- It is below the original SRAS curve, it is below the original SRAS curve because it is assumed that investment has reduced costs of production
Draw stagflation from a supply-side shock due to uk oil crisis 1979; crude prices double to 40$ a barel
What demand side shock did Nigel Lawson cause in 1986-88
- 1986-88, the Chancellor of the Exchequer, Nigel Lawson, helped fuel a boom with low interest rates and income tax cuts. The Lawson boom saw rising inflation, to combat this the government raised interest rated from 7.5% in May 1988 to 15% in 1989 and kept them at this level for nearly a year
- Combined with a high value of the pound, AD fell. As shown in Figure 14, this led to a recession with falling output and downward pressure on prices as the economy moved from A to B
- All other things equal the economy would have returned to long-run equilibrium at C
Downturn of 08-13 was caused by a banking crisis, cuasing lending by banking to fall sharply, along with a fall in confidence by consumers and businesses
How do Keynsians differ with Classical economists with fiscal policy
Keynsians differ with Classical economist as they want demand side policy rather than supply side policy
What is the multiplier process
- The multiplier effect occurs when there is new demand in an economy leads to an injection of more income into the circular flow of income, which leads to economic growth.
- The multiplier effect refers to how an initial increase in AD leads to an even bigger increase in national income.
- It occurs since ‘one person’s spending is another person’s income’.
What is the MPW (Marginal Propensity to Withdraw)
MPS (save) , MPT (tax) , MPM (import)
What is the MPC (Marginal Propensity to Consume)
- A consumer’s marginal propensity to consume is the **proportion of each additional pound of household income that is spent. **
- The higher the MPC, the bigger the size of the multiplier.
How do you calcuate the mulitplier
1/MPW or 1/(1-MPC)
What are some factors that cause a high multiplier value
- Economy has plenty of spare capacity (negative output gap) to meet higher demand
- Marginal propensity to import and tax is low
- High propensity to consume any extra income (i.e. a low propensity to save)
What are some factors that cause a low multiplier value
- Economy is close to it’s capacity limits e.g. during a boom phase
- Propensity to import goods & services is high – extra demand leaks from circular flow
- Higher inflation causes rising interest rates which then dampens other components of AD
Why does a high multiplier value need spare capacity
If short-run aggregate supply is inelastic, the full multiplier effect is unlikely to occur, because increases in AD will lead to higher prices rather than a full increase in real national output.
How does the multiplier effect interact with a tax cut to cause an overall rise in AD
- Firstly, if consumers maintain the same spending habits, they will have more disposable income left over to buy more goods.
- Secondly, they may be encouraged to buy goods (especially expensive electrical goods) etc. because they are cheaper.
herefore, in theory, a tax cut should boost consumer spending and this
leads to an overall rise in AD.
This means firms will get an increase in output encouraging an expansion of labour.
(multiplier)
What is the negative multiplier effect
negative multiplier effect occurs when an initial withdrawal of spending
from the economy leads to knock-on effects and a bigger final fall in real GDP.
What are the causes of the negative multiplier effect
It could be a decrease in injections:
* Fall in C, I, X, G
Or an increase in withdrawals from the circular flow.
- T, I, S
What limits a spiralling negative multiplier effect
-
Welfare state. Unemployed received benefits from the government to
maintain spending - Injection from abroad. One economy may experience a slump, but then
see demand rise from abroad. - Withdrawals countered by new injections. Higher tax is a withdrawal
from the circular flow and may cause a fall in demand. But, with higher
tax, the government may spend more on investment. -
Monetary policy. In response to falling demand, monetary authorities
may cut interest rates to make borrowing cheaper and boost demand.
What are key evaluations of the multiplier effect
- Injections cause crowding out
- Time lag for full multiplier effect
What are some factors that cause a low multiplier value
- Economy is close to it’s capacity limits e.g. during a boom phase
- Propensity to import goods & services is high – extra demand leaks from circular flow
- Higher inflation causes rising interest rates which then dampens other components of AD
What is the liquidity trap
after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rather than holding a debt which yields so low a rate of interest.
What are the four key parts of the Circular Flow of Income Model and explain what they do
- Households receive income through wages, investments and they then buy goods
- Businesses hire factor inputs when making products for which they pay wages
- Government collects taxes (T) to fund spending
- The UK buys imports from other countries, (M) and overseas buy exports (X)
