2.4 National Income

Question 1

Explain the circular flow of income with just households and firms

Answer 1

• households own all the wealth and resources so provide the firms with land, labour and capital in return for rent, wages, interest and profits
• this money is used to buy goods and services produced by the firms
• money flows in one direction and goods, services and factors of production flows in another
• in the model, the national output = national expenditure = national income

Question 2

In a more complex circular flow of income model, what goes the government represent

Answer 2

• they take money out of the economy through taxation and add money by spending. If the government spends more than it takes away, it can increase the circular flow of income

Question 3

In a more complex circular flow of income, what does financial services represent

Answer 3

They inject money into the system through investment and take away money when consumers or producers save

Question 4

In a more complex circular flow of income, what does foreign markets represent

Answer 4

Foreign markets are added As foreigners buy British goods so exports add money to the flow but British people want to buy foreign goods so imports take money away from the flow

Question 5

Difference between wealth and income

Answer 5

Wealth is a stock of assets whilst income is a flow.

Wealth is things people own: houses, possessions. Whilst income is the money they receive: money from work, interest from savings.

Question 6

What are injections

Answer 6

Injections are monetary additions to the economy
• government spending
• investment
• exports

Question 7

What are withdrawals

Answer 7

Withdrawals are where money is removed from the economy
• taxes
• savings
• imports

Question 8

Balance of injections/withdrawals on economic growth

Answer 8

If the sum of injections is greater than the sum of withdrawals, then the economy will be growing

If injections are smaller than withdrawals, it will be shrinking

Question 9

Short term agreements between Keynesian and classical (AD&AS)

Answer 9

Both Keynesian and classical economists agree that in the short run AD will be downward sloping and AS will be upward sloping

Question 10

What is classical LRAS like in the long term

Answer 10

As the classical LRAS curve is perfectly in elastic, a shift of the AD curve would not affect long run national output and would only effect price levels

Question 11

What is the classical view as the only way to increase output and why

Answer 11

The only way to increase output is by increasing the LRAS. This is because classicists conclude that an increase in AD will increase price and output in the short run, but over time, prices will continue to rise as the economy move back to long term equilibrium (this part is why they don’t believe)

Question 12

What will a rise in LRAS lead to

Answer 12

Lower prices and higher output

Question 13

What method of generating economic growth do classical economists prefer

Answer 13

Supply-side policies over demand management

Question 14

Keynesian main disagreement with classical in terms of LRAS

Answer 14

Keynesian economists agree with classicists that there is full employment where the LRAS is vertical. However, they believe there can be equilibrium at less than full employment, where the curve is horizontal.

Question 15

What is the multiplier process

Answer 15

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

It is the ratio of the final change in income to the initial change in injection; an the figure multiplied by the original injection to find final change in income

Question 16

How is the size of the multiplier determined

Answer 16

Determined by how much of an increase in income people will spend, the MPC. The Lower the leakages, the higher the MPC, the bigger the multiplier

Question 17

Why is the multiplier able to work

Answer 17

The multiplier is able to work due to the concept of circular flow, since one persons spending is another’s income.

Question 18

IMF calculation of multiplier in developed and developing countries

Answer 18

The IMF have calculated that in developed countries, the multiplier tends to be around 1.5 in the LR and about 1.6 for developing countries

Question 19

What’s a negative multiplier effect

Answer 19

When there is a withdrawal from the economy that can lead to an even further fall in income, decreasing economic growth and possibly leading to a decline in the economy.

Question 20

Positive Effects of the multiplier in the economy

Answer 20

• means that growth can occur quicker, as any injections lead to a bigger increase in national income. Injections can be targeted at those with the biggest MPC in order to increase size of the multiplier

Question 21

Potential negative effects of the multiplier

Answer 21

• impossible for the government to know the exact effect of their spending as it is difficult to know the size of the multiplier
• there will be a time lag between increase in income and the full effect of that increase as not everyone will spend the money straight away
• the overall effect on the economy will depend on the change in AD and the elasticity of the AS curve

Question 22

With government intervention in terms of the multiplier, who does the government target

Answer 22

They target those with the highest MPC, usually those on lower incomes

Question 23

Define Marginal propensity to consume

Answer 23

The increase in consumption following an increase in income

Question 24

Define marginal propensity to save

Answer 24

The increase in savings following an increase in income

Question 25

Define marginal propensity to tax

Answer 25

The increase in taxation following an in income

Question 26

Define marginal propensity to import

Answer 26

MPM - the increase in imports following an increase in income

Question 27

Define marginal propensity to withdraw

Equation

Answer 27

The increase in leakages following an increase in income

MPW=MPS+MPT+MPM

Question 28

Multiplier equation

Answer 28

1 1
———— = ———
(1-MPC) MPW

Question 29

Multiplier effects of a change in AD

Answer 29

• leads to an increase in AD higher than the original increase but for it to have the desired effect, there must be sufficient spare capacity in the economy for extra output to be produced
• if the AS is perfectly elastic, like on the classical LRAS curve, then the only impact of the multiplier will be to increase price; it will not affect output in the long run, although it will in the short run
• the more elastic the curve, the smaller the effect in price but the bigger effect on output
• therefore, as with any increase in AD, the effect of the multiplier depends on the shape of the AS curve and whether it is short run or long run. The size of the increase in AD will depend on both the size of the initial increase in AD and size of the multiplier