2.4 - National Income Flashcards
Theme 2: The UK economy – performance and policies
Circular flow of income
It is a model showing the movement of money, goods, and services between households and firms in an economy.
What do households supply firms with?
The factors of production in return for wages, rent, dividends and profit.
Circular flow of income formula
National output = National expenditure = National output
What are the three main components in the circular flow of income?
Households – provide factors of production and receive income.
Firms – produce goods and services and pay households.
Government/financial/international sectors – introduce injections and withdrawals.
What is the difference between income and wealth?
Income: Flow of money received (e.g., wages, dividends).
Wealth: Stock of assets owned (e.g., houses, shares).
What are injections in the circular flow of income?
Investment (I)
Government spending (G)
Exports (X)
What are withdrawals (leakages) from the circular flow?
Savings (S)
Taxes (T)
Imports (M)
What happens when injections > withdrawals?
The circular flow expands, increasing national income (economic growth).
What happens when withdrawals > injections?
The circular flow contracts, reducing national income.
When is the economy in equilibrium?
When the rate of withdrawals = the rate of injections
What is equilibrium real national output?
AD = AS
What happens when AD increases?
Equilibrium shifts right, leading to higher real GDP and possibly a higher price level (inflation).
What happens when AS increases?
Higher output at a lower price level—a sign of non-inflationary growth.
Multiplier
How an initial increase in AD leads to an even bigger increase in national income.
Multiplier ratio
Multiplier = 1/(1-MPC)
Multiplier = 1/MPW
where MPW = MPS, MPT, MPM
Multiplier process
An initial injection leads to increased income → more consumption → further income → repeated rounds of spending.
What are marginal propensities?
MPC: Marginal Propensity to Consume
MPS: Marginal Propensity to Save
MPT: Marginal Propensity to Tax
MPM: Marginal Propensity to Import
How do marginal propensities affect the multiplier?
A higher MPC means a larger multiplier. A higher MPW (savings, tax, imports) means a smaller multiplier.
What is the significance of the multiplier for shifts in AD?
The larger the multiplier, the greater the shift in AD from an initial change in spending.
Reverse multiplier
A withdrawal from the circular flow causes a larger final decrease in national income.
