2.4 - National income Flashcards
What do households bring to firms?
The factors of production:
1. Land
2. Labour
3. Capital
4. Entrepreneurship
What do firms bring to households?
Goods and services:
1. Rent
2. Wages
3. Interest
4. Profits
What are the injections into the circular flow of income?
- Investment (I)
- Government spending (G)
- Exports (X)
What are the leakages?
- Savings (S)
- Taxation (T)
- Imports (M)
Draw the model of the circular flow of income
Difference between income and wealth?
Income - flow of assets (e.g. interest, wage)
Wealth - stock of assets (e.g. possessions, property)
What are the GDP methods?
- Output method (through goods and services)
- Income method (through factor inputs)
- Expenditure method (through consumer expenditure)
Why do classical economists argue that the LRAS curve is perfectly inelastic?
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
What is their overlying argument?
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
Why do classical economists prefer supply side policies over demand side policies?
Because it increases output without having an inflationary effect in the economy
Draw this on a diagram
What do Keynesian economists believe in?
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
What happens when AD shifts out in full employment / boom?
It will cause prices to rise (inflationary pressure) but there will be no change in output
What happens when AD shifts out in a recession?
Opposite effect, there will be no inflationary effect but rather, output will increase
Draw a diagram to show this
Why do Keynesian economists argue against supply side policies (i.e. increasing LRAS) during a recession?
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)
Definition of multiplier
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
What is the size of the multiplier determined by?
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
What did the IMF calculate?
They found that for developed countries, the multiplier will be around 1.5 and 1.6 for developing countries
Why does the multiplier effect work?
Due to the idea of the circular flow of income - since a person’s spending is another’s income
What is the effect of multiplier on economy?
- Growth can happen quicker
- If government wants to stimulate the economy, then they should focus on giving to people with highest MPC (those on low incomes)
Definition of MPC
The measure of an increase in the proportion of income that a household is likely to spend on goods and services than save
Definition of MPS
The measure of proportion of an increase in income that a household is likely to save rather than spend
Definition of MPT
The measure of proportion of an increase in taxation following the increased proportion of income
Definition of MPM
The measure of the proportion of an increase in imports following the proportion of an increase in income
What are the equations used to calculate multiplier?
1.
Multiplier = 1 / (1 - MPC)
Multiplier = 1 / MPW
If MPC is 0.9 and the increase in government spending is £50,000, what will the increase in national income be?
Multiplier = 1 / 1 - MPC
= 1 / (1-0.9)
= 10
National income = £50,000 x 10
= £500,000
What is the effect of the multiplier on AD?
- Multiplier can only have an effect if there is sufficient spare capacity in the economy (i.e. there is no full output)
- If AS is perfectly inelastic (classical), then the effect will only increase prices, not output
What does the multiplier effect depend upon for AD?
It depends on the shape/elasticity of the AS curve and whether it is in the SR or LR
When can the multiplier effect happen?
It does not have an effect on output in the LR
What is the overall conclusion on multiplier?
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)
