2.4 national income

Question 1

what is the circular flow of income?

Answer 1

an economic model that shows how money flows throughout the economy between households and firms

Question 2

explain the circular flow of income

Answer 2

• households own all the wealth and resources so provide the firms with land, labour and capital in return for rent, wages, interest and profits
• they use this money to buy goods and services produced by the firms
• money flows in one direction and goods, services and factors of production flow in another
• there are three ways of measuring the level of economic activity: the national output, the value of the flow of goods and services from firms to households; the national expenditure, the value of spending by households on goods and services; and the national income; of income paid by firms to households in return for land, labour, capital and enterprise.
• In this simple model, the national output=national expenditure=national income.

Question 3

dicuss problems with the circular flow of income diagram

Answer 3

• Firstly, the government needs to be added: they take money out of the economy through taxation (T) and add money by spending (G). If the government spends more than it takes away, it can increase the flow of income.
• Next, we add to the model by introducing financial services who can inject money into the system through investment (I) and take money away when consumers or producers save (S)
• Finally, foreign markets are added as foreigners buy British goods so exports (X) add money to the flow but British people want to buy foreign goods so imports (M) take money away from the flow. The difference between the level of imports and exports is the balance of trade.

Question 4

what is the difference between income and wealth?

Answer 4

• income is the money that a person recieves in exchange for something; it moves from one agent to another; it is seen as a flow of money
• wealth is the money that a person holds; it may have built up from wages or investment returns, but it does not go anywhere; it is seen as a stock as it is money that is kept stored; wealth can be savings accounts or items such houses (assests)

Question 5

iv. What is the opportunity cost of accumulating wealth?

Question 6

under what circumstances would increases in income result in an increase in wealth?

Question 7

under what circumstances would increases in wealth result in an increase in income?

Answer 7

accumulated wealth may provide extra income from interest, rents or share dividends

Question 8

vii. What is the opportunity cost of increased future wealth?

Question 9

what is an injection?

Answer 9

things that outside economic agents do with their incomes that result in bringing more money into the circular flow; there is now more money going around the system

Question 10

give 3 injections

Answer 10

1. government spending (G)
2. investment (I)
3. exports (X)

Question 11

what is a withdrawal?

Answer 11

things that economic agents (within the system) do with their incomes that result in taking money out of the circular flow; by taking money out, it is no longer going around the diagram

Question 12

give 3 withdrawals

Answer 12

1. taxes (T)
2. savings (S)
3. imports (M)

Question 13

what happens when injections are bigger than withdrawals (i.e we have net injections)?

Answer 13

the economy would be growing

Question 14

what happens when withdrawals are bigger than injections (i.e we have net withdrawals)?

Answer 14

the economy would be shrinking

Question 15

what happens when withdrawals = injections?

Answer 15

national income remains the same

Question 16

what is real national output?

Answer 16

the output of the economy once inflation has been accounted for

Question 17

what are the axes on a AS-AD graph?

Answer 17

• y-axis - price levels
• x-axis - real GDP

Question 18

what condition must be achieved for real national output to be in equilibrium?

Answer 18

at the point where AS is equal to AD

Question 19

explain what happens to real national output if AD increases

Answer 19

• firms within the economy will increase their ssupply to meet this new demand for their goods
• this results in a movement along the AS curve until it meets the point where the new AD curve intersects it
• at this point the market is in equilibrium again and real national output has increased

Question 20

explain what happens to real national output if AD decreases

Answer 20

• firms within the economy will decrease their supply to avoid the excess unconsumed products they would be left with from the lack of demand
• this results in a movement along the As curve until it meets the point where the new AD curve intersects it
• at this point the market is in equilibrium again and real national output has decreased

Question 21

explain what happens to real national output if AS increases

Answer 21

• because maybe tax rates have been cut or technology lowers the cost of production, then firms are able to supply goods at a cheaper price
• this is more likely to happen if there are high levels of competition within a market as the increase in customers may increase profits more than the decrease in price would
• at lower prices more consumers are willing to buy the good, which results in a movement along the AD curve until it reches the new AS curve
• the market is in equilibrium again and real national output has increased

Question 22

explain what happens to real national output if AS decreases

Answer 22

• perhaps because a natural disaster has damaged machinery and raw materials, then costs of production will increase and as response firms will increase prices
• at higher prices fewer consumer are willing to buy the good, which results in a movement along the AD curve until it reaches tthe new AS curve
• the market is in equilibrium again and real national output has decreased

Question 23

what is the multiplier?

Answer 23

the process occurs after an injection into the economy and causes it to grow beyond the original amount injected

Question 24

what is the multiplier ratio?

Answer 24

the number of times a rise in national income is larger than the rise in the initial injection of AD, which led to the rise in national income

Question 25

what is MPS?

Answer 25

the proportion of income that will be leaked by saving