2.4 National Income Flashcards
Explain the circular flow of income with just households and firms
• 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
In a more complex circular flow of income model, what goes the government represent
• 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
In a more complex circular flow of income, what does financial services represent
They inject money into the system through investment and take away money when consumers or producers save
In a more complex circular flow of income, what does foreign markets represent
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
Difference between wealth and income
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.
What are injections
Injections are monetary additions to the economy
• government spending
• investment
• exports
What are withdrawals
Withdrawals are where money is removed from the economy
• taxes
• savings
• imports
Balance of injections/withdrawals on economic growth
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
Short term agreements between Keynesian and classical (AD&AS)
Both Keynesian and classical economists agree that in the short run AD will be downward sloping and AS will be upward sloping
What is classical LRAS like in the long term
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
What is the classical view as the only way to increase output and why
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)
What will a rise in LRAS lead to
Lower prices and higher output
What method of generating economic growth do classical economists prefer
Supply-side policies over demand management
Keynesian main disagreement with classical in terms of LRAS
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.
What is the multiplier process
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
How is the size of the multiplier determined
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
Why is the multiplier able to work
The multiplier is able to work due to the concept of circular flow, since one persons spending is another’s income.
IMF calculation of multiplier in developed and developing countries
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
What’s a negative multiplier effect
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.
Positive Effects of the multiplier in the economy
• 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
Potential negative effects of the multiplier
• 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
With government intervention in terms of the multiplier, who does the government target
They target those with the highest MPC, usually those on lower incomes
Define Marginal propensity to consume
The increase in consumption following an increase in income
Define marginal propensity to save
The increase in savings following an increase in income
Define marginal propensity to tax
The increase in taxation following an in income
Define marginal propensity to import
MPM - the increase in imports following an increase in income
Define marginal propensity to withdraw
Equation
The increase in leakages following an increase in income
MPW=MPS+MPT+MPM
Multiplier equation
1 1
———— = ———
(1-MPC) MPW
Multiplier effects of a change in AD
• 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
