2.4 National Income Flashcards
2.4.1, 2.4.2, 2.4.3, 2.4.4 The circular flow of income, injections and withdrawals, equilibrium levels and the multiplier
Define national income
The total value of income paid by firms to households in return for the factors of production
Define gross domestic product (GDP)
The total value of goods and services produced in an economy
What are the methods of measuring GDP?
- Expenditure method
- Income method
- Output method
All three of these methods can be used as all three value should be equal
National expenditure = national income = national output
What is the expenditure method?
Adding up the total expenditure (components of AD) on an economy’s goods and services (in a year)
What is the income method (to calculate GDP)?
Adding up all the factor incomes earned in the economy (in a year)
What is the output method (to calculate GDP)?
Adding up the final value of all goods and services (in the main economic sectors) produced in the economy (in a year)
What is the circular flow of income (CFI)?
A model of the economy which shows the movement of spending and income throughout, illustrating the connection between output, expenditure and income and showing how national income/GDP is calculated
Stages of the CFI diagram (4)
- Supply of capital, enterprise, land and labour (households to firms): firms use these factors of production to produce output
- National Income (Y - firms to households): compensation in the form of interest, profit, rent and wages
- Consumer expenditure (households to firms): incomes are spent to buy goods and services
- Output of goods and services (firms to households): revenue received from selling existing output can be used to increase output by buying more resources, etc.
What are injections (J)?
Additions to the CFI in the forms of investment (I), government spending (G) and exports (X) which boost the CFI
What are leakages/withdrawals (W)?
Removals from the CFI in the form of savings (S), taxation (T) and imports (M)
What happens if injections are greater than withdrawals?
(I + G + X) > (S + T + M): more money entering than leaving the CFI
1. There is an increase in the flow of money due to more factors of production being used, therefore more incomes being paid in return
2. More spending takes place, as households now have higher disposable incomes, increasing AD and causing more output to be required
3. Resulting in an increase in the level of national income (positive economic growth)
What happens if withdrawals are greater than injections?
(S + T + M) > (I + G + X): more money exiting than entering the CFI
1. There is a decrease in the flow of money due to less factors of production being used, therefore fewer incomes have to be paid in return
2. Less spending takes place, as households have less disposable income, decreasing AD and causing less output to be required
3. Resulting in a fall in the level of national income (recession)
What happens in injections are equal to withdrawals?
(I + G + X) = (S + T + M): the economy is in macroeconomic equilibrium
Economic growth does not change
What is the multiplier?
The ratio of the final change in income to the initial change in injection
Simple multiplier formula
K = 1/MPS
or
K = 1/(1-MPC)
Extended multiplier formula
K = 1/MPW
or
K = 1/(1-MPC)
What components make up the marginal rate of withdrawals (MRW)? (3)
- MPS = marginal propensity to save
- MPM = marginal propensity to import
- MRT = marginal rate of taxation
What happens to the value of the multiplier if there is a change in the the level of withdrawals (MPW)?
Rise in the level of withdrawals = reduces the value of the multiplier
Fall in the level of withdrawals = increases the value of the multiplier
What happens to the value of the multiplier if there is a change in the the level of injections (MPC)?
Rise in the level of injections = increases the value of the multiplier
Fall in the level of injections = reduces the value of the multiplier
When does the multiplier effect occur?
When an initial increase in injections into the CFI causes larger final increase in real national income
When does the negative multiplier effect occur?
When an initial increase in withdrawals from the CFI causes a fall in real national income
What is the marginal propensity to consume (MPC)?
The proportion of any extra income that is spent on consumption
What is the marginal propensity to save (MPS)?
The proportion of any new income that is saved
What is the marginal rate of taxation (MRT)?
The proportion of any new income that is paid in taxes
What is the marginal propensity to import (MPM)?
The proportion of any new income that is used to import
How does an increase in the MPC cause the multiplier effect to increase?
Consumers are spending more on domestically produced goods/services, injecting more money into the CFI
How does an increase in the MPM cause the multiplier effect to decrease?
Consumers spending more on imports causes leakages from the CFI as the money spent is withdrawn from the flow
How does an increase in the MRT cause the multiplier effect to decrease?
If the govt. increases taxation (amount/percentage paid out of income), consumers will now have less disposable income to consume, decreasing the level of injections and AD
How does the multiplier effect affect AD?
Leads to an increase in AD, higher than the original shift (the bigger the multiplier, the bigger the shift)
How is short-term macroeconomic equilibrium shown?
When AD = SRAS
How is long-term macroeconomic equilibrium shown?
When AD = SRAS = LRAS
