2.4 - National income

Question 1

What do households bring to firms?

Answer 1

The factors of production:
1. Land
2. Labour
3. Capital
4. Entrepreneurship

Question 2

What do firms bring to households?

Answer 2

Goods and services:
1. Rent
2. Wages
3. Interest
4. Profits

Question 3

What are the injections into the circular flow of income?

Answer 3

1. Investment (I)
2. Government spending (G)
3. Exports (X)

Question 4

What are the leakages?

Answer 4

1. Savings (S)
2. Taxation (T)
3. Imports (M)

Question 5

Draw the model of the circular flow of income

Question 6

Difference between income and wealth?

Answer 6

Income - flow of assets (e.g. interest, wage)
Wealth - stock of assets (e.g. possessions, property)

Question 7

What are the GDP methods?

Answer 7

1. Output method (through goods and services)
2. Income method (through factor inputs)
3. Expenditure method (through consumer expenditure)

Question 8

Why do classical economists argue that the LRAS curve is perfectly inelastic?

Answer 8

They do not believe that the rise in unemployment will cause a rapid fall in real wages - therefore the change in prices will have no effect in the changes of output

They believe that the economy will always return to full employment - therefore no unemployment in the long run

Question 9

What is their overlying argument?

Answer 9

They argue that the increase in AD will increase output and prices in the SR, but overtime, in the LR, price will continue to rise but not output therefore having an inflationary effect

Output has no changed, the only way to increase it is through increasing LRAS

Question 10

Why do classical economists prefer supply side policies over demand side policies?

Answer 10

Because it increases output without having an inflationary effect in the economy

Question 11

Draw this on a diagram

Question 12

What do Keynesian economists believe in?

Answer 12

They believe that there can be a equilibrium at less than full employment - as the rise in unemployment will not cause real wages to rise rapidly

Question 13

What happens when AD shifts out in full employment / boom?

Answer 13

It will cause prices to rise (inflationary pressure) but there will be no change in output

Question 14

What happens when AD shifts out in a recession?

Answer 14

Opposite effect, there will be no inflationary effect but rather, output will increase

Question 15

Draw a diagram to show this

Question 16

Why do Keynesian economists argue against supply side policies (i.e. increasing LRAS) during a recession?

Answer 16

This is because it will have no effect whatsoever on price or output - instead, the government should focus on stimulating the economy through demand side policies (i.e. influencing through increase in AD)

Question 17

Definition of multiplier

Answer 17

The idea that an increase in AD because of an increased injection can lead to a further increase in national income

Increased injection = rise in consumer spending = rise in income = further rise in consumer spending

Question 18

What is the size of the multiplier determined by?

Answer 18

Determined by the marginal propensity to consume (MPC) - i.e. how much an increase in income will people spend

Lower leakages = higher injections = bigger multiplier

Question 19

What did the IMF calculate?

Answer 19

They found that for developed countries, the multiplier will be around 1.5 and 1.6 for developing countries

Question 20

Why does the multiplier effect work?

Answer 20

Due to the idea of the circular flow of income - since a person’s spending is another’s income

Question 21

What is the effect of multiplier on economy?

Answer 21

1. Growth can happen quicker
2. If government wants to stimulate the economy, then they should focus on giving to people with highest MPC (those on low incomes)

Question 22

Definition of MPC

Answer 22

The measure of an increase in the proportion of income that a household is likely to spend on goods and services than save

Question 23

Definition of MPS

Answer 23

The measure of proportion of an increase in income that a household is likely to save rather than spend

Question 24

Definition of MPT

Answer 24

The measure of proportion of an increase in taxation following the increased proportion of income

Question 25

Definition of MPM

Answer 25

The measure of the proportion of an increase in imports following the proportion of an increase in income

Question 26

What are the equations used to calculate multiplier?

Answer 26

1.

Multiplier = 1 / (1 - MPC)

Multiplier = 1 / MPW

Question 27

If MPC is 0.9 and the increase in government spending is £50,000, what will the increase in national income be?

Answer 27

Multiplier = 1 / 1 - MPC
= 1 / (1-0.9)
= 10

National income = £50,000 x 10
= £500,000

Question 28

What is the effect of the multiplier on AD?

Answer 28

1. Multiplier can only have an effect if there is sufficient spare capacity in the economy (i.e. there is no full output)
2. If AS is perfectly inelastic (classical), then the effect will only increase prices, not output

Question 29

What does the multiplier effect depend upon for AD?

Answer 29

It depends on the shape/elasticity of the AS curve and whether it is in the SR or LR

Question 30

When can the multiplier effect happen?

Answer 30

It does not have an effect on output in the LR

Question 31

What is the overall conclusion on multiplier?

Answer 31

It has little effect on output when there is little/no spare capacity - the rising demand will just affect prices (negative effect as it will cause inflationary pressure)