2.4 National income LS5-7

Question 1

National income definition?

(Y)

Answer 1

The value of income paid by firms to households in return for land, labour and capital

Question 2

National expenditure definition?

(E)

Answer 2

The value of spending by households on goods and services

Question 3

National output definition?

(O)

Answer 3

The value of flow of goods and services from firms to households

Question 4

Closed economy vs open economy?

Answer 4

No foreign trade in closed economies but there is foreign trade in open economies

Question 5

Who owns the wealth of the nation?

Answer 5

Households

Question 6

Who own the stock of land, labour and capital used to produce goods and services and who do they supply this to?

Answer 6

Households, supply these factors to firms

Question 7

Describe circular flow of income for a closed economy without government, just households and firms.

Answer 7

• Households receive payments for hiring their land (rent), labour (wages), capital (interest) and enterprise (profit)
• They spend that money on the goods and services produced by firms (consumption)
• Firms purchase factors of production from households to produce goods and services and sell them to households

Question 8

Three ways of measuring the level of economic activity using a circular flow diagram:

Answer 8

• National output (O): value of flow of goods and services from firms to households
• National expenditure (E): the value of spending by households on goods services
• National income (Y): The value of income paid by firms to households in return for factors of production (rent, wages, interest and profit)

so O≡E≡Y

Three ways of measuring the same flow so are identical

Question 9

Injections into circular flow of income definition and what are they?

Answer 9

Variables in an economy that add to the circular flow of income
* I, G, X

Question 10

Withdrawals from the circular flow of income and what are they?

Answer 10

Variables in an economy that remove money flows from the circular flow of income
* Taxation (T), Savings (S), Imports (M)

Question 11

What do both Keynesian and classical economists agree on?

Answer 11

That in the short run, AD curve is downward sloping and AS curve is upward sloping

Question 12

In the short run, how do changes in aggregate demand level affect real output and price levels?

Answer 12

• Increase in AD = AD curve shifts to the right = rise in equilbrium output = rise in price levels
• Decrease in AD = AD curve shifts to the left = fall in equilbrium output = fall in price levels

Question 13

In the short run, how do changes in aggregate supply affect real output and price levels?

Answer 13

• Increase in AS = AS curve shifts to the right = rise in equilibrium output = fall in prices
• Decrease in AS = AS curve shifts to the left = fall in equilibrium output = rise in prices

Question 14

What does the LRAS curve look like in the classical model and what does it show?

Answer 14

Vertical, shows the supply curve for the economy at full employment

Question 15

What is the key point of disagreement between Keynesian and Classical economists?

Answer 15

• The extent to which workers react to unemployment by accepting real wages
• Classical economists think that if theres a rise in unemployment, wages will be rapidly cut to increase the quantity demanded for labour, returning the economy to full employment automatically
• Keynesian economists think that money wages are sticky downwards, meaning they think that workers will refuse to take money wage cuts so the labour market will not clear quickly

Question 16

In the classical model in the long-run, how do rises in aggregate demand affect real output and price levels?

Answer 16

• Rise in AD = AD curve shifts rightwards = a movement up the SRAS curve = small rise in prices and rise in output BUT beyond LRAS so economy is now in long run disequilibrium
• SO, AS has to decrease so responds with wage increases etc and SRAS has to shift leftwards so that AD equals LRAS = rise in price levels = returns back to LR equilibrium
• Price levels and output initially increase, but output falls as it moves back to long run equilibrium so in the long run, rise in AD = rise in prices and no effect on output so purely inflationary

Question 17

For the Keynesian LRAS model, describe what a rise in aggregate demand does at the three different points on the Keynesian LRAS curve

Answer 17

• Deep depression zone: rise in AD = rise in output without rise in prices due to unused resources available
• Just below full employment: rise in AD = rise in output and prices
• At full employment: rise in AD = rise in price without rise in output

Question 18

In the classical model, how do rises in aggregate supply in the long run affect prices and real output?

Answer 18

• Rise in LRAS = LRAS curve shifts rightwards = output increases = prices fall

Question 19

In the long run for the Keynesian model, how do increases in aggregate supply affect real output and prices at the three different zones?

Answer 19

• Deep depression zone: rise in AS = no effect on real output or price levels, only rises in AD can take economy out of deep depression zone
• Just below full employment: rise in AS = rise in output = fall in prices
• At full employment: rise in AS = rise in output = fall in prices

Question 20

How does investment affect both aggregate supply and aggregate demand?

Answer 20

• Increases in investment = rise in AD (Investment is a component of AD)
  BUT
• Since investment is the addition to the capital stock of the economy, in the long run, this means the productive potential of the economy increases, causing a rise in LRAS too

Not all investment results in increased production, can be inflationary

Question 21

What is the multiplier effect?

Answer 21

When injections/withdrawals into the circular flow of income stimulate/reduce spending

Question 22

Formula for the multiplier ratio?

Answer 22

1/MPW
OR
1/(1-MPC)
OR
1/MPS

MPS + MPC = 1

Question 23

MPS formula?

Answer 23

Δ savings / Δ Income

Question 24

MPC formula?

Answer 24

Δ consumption / Δ income

Question 25

MPT formula?

Answer 25

Δ taxation / Δ income

Question 26

MPM formula?

Answer 26

Δ spending on imports / Δ income

Question 27

MPW?

Answer 27

MPS + MPT + MPM

Question 28

What are the effects of a higher multiplier?

Answer 28

Injections have a larger impact on national income, AD increases by a larger amount

Question 29

What are the effects of increases in AD?

Answer 29

• Higher output
• Higher employment due to an increase in firm’s need for labour
• Higher inflation if economy is not in deep depression zone/recession