2.4 national income Flashcards
The circular flow of income
Households: provide factors of production (labour, land, capital) to firms to receive wages, rents, and profits in return
Firms: Produce g+s, pay households for FOP, receive revenue from selling products
Government: collects taxes from households and firms, spend on public services and welfare
Financial sector: facilitates saving and investment by households and firms
Foreign sector: engages in trade through exports and imports
Flows in the circular flow of income model
Real flow: movement of goods and services (labour products)
Money flow: movement of money (wages, consummer spending)
Withdrawals and injections
Withdrawals:
-savings
-taxes
-imports
(all remove money from circular flow)
Injections:
-investment
-gov spending
-exports
(add money to circular flow)
Wealth vs income
Income:
-flow of money that goes to FOP
-measured over a period of time
Wealth:
-stock of assets owned at a given point in time
-Includes physical (cars, houses) and financial assets (stocks, boonds)
Impact of injections and withdrawals
-When injections exceed withdrawals there is an increase in national income leading to economic growth
Equilibrium real national output
-Level where AD=AS
-No tendancy for economy to change its output level - no excess supply/demand
-Price stability - no inflationary pressure
-Full employment - all available resources utilised efficiently
-Sustainable output in LR
Shifts in AD
-higher confidence
-tax cuts
-gov spending
-increased output and price level
Shifts in AS
-Increase in quality and quantity of FOP
-lower price, increase in ouutput
The multiplier ratio
-Total change in national income resulting from a change in spending
Multiplier = 1/(1-MPC)
The multiplier process
-Initial increase in spending injects money into economy
-Spending becomes income for households who then spend a portion of this income
-This spending generates additional income for others, continuing the cycle
-Each round of spending is smaller due to withdrawals
Effects of the multiplier on the economy
-Economic expansion as the multiplier amplifies effects of intial spending increases, leads to growth
-Job creation as labour is derived demand
-Income growth from higher demand so enchanced living standards
Marginal propensities
MPC: proportion of additional income that households spend on consumption
-Higher MPC leads to larger multiplier as more income is recycled into the economy
MPS: proportion of additional income houseolds save
-High MPS leads to small multipler - withdrawal
MPT: proportion od additional income that is spent in taxes
-Higher MPT reduces multiplier
MPM: proportion of additional income spent on imports
-high MPM reduces multiplier
Multiplier formulas
1/(1-MPC)
1/MPW
MPW=MPS+MPT+MPM
Significance of multiplier for shifts in AD
-The nultiplier effect means that an initial increase in AD results in a larger overall increase in national output and income
-Allows policymakers to design effective fiscal policies to manage economic cycles
-Fiscal stimulus can be used to combat recessions
