2.5.2 Circular flow of income, expenditure and output

Question 1

Leakages out of the economy

Answer 1

Reduce demand for domestically produced goods and services by diverting part of peoples income into savings

Question 2

injections into the economy

Answer 2

Investment, government, expenditure and exports - increase demand for domestically produced goods and services

Question 3

Aggregate demand

Answer 3

Sum total of demand from all sources in the economy -> includes consumption, investment, government expenditure and exports - imports

Question 4

Aggregate supply

Answer 4

Total output from all sources in the economy

Question 5

Macroeconomics

Answer 5

Economy as a whole

Question 6

what is the aggregate demand equation

Answer 6

AD = C + I + G + (x-m)

Question 7

the circular flow of income with injections/withdrawals

Answer 7

Injections → money put into the economy (J) = I + G + Y
Withdrawals → money taken out of the economy (W) = S + T + M

• Households give firms labour, I
• Firms give them income, W
• Households give firms consumer spending ( C ), I
• Consumers also spend on imports (M) (W) and exports (X) (I)
• Firms give households goods and services, W
• Households save some of their money in the bank (S), W
• Banks invest this money back into the firms (I), I

Household wages also get taxed by the government (T), W
Government spending improv es the economy → roads, bridges, firms etc (G), I

Question 8

when will the economy grow (I and W)

Answer 8

• The economy will grow when inJ > W
• There is strong investment government spending and demand for exports
• Economic growth will slow/shrink when inJ < W
• When savings increase or demand for imports increases
• When the economy is growing, aggregate demand increases

Question 9

spending and savings and I and W into economy

Answer 9

• When there is an increase in real income, there is an increase in consumer spending, new exports and investment into business; this leads to an increase in ninjections and therefore this leads to a boom.
• Savings → when a recession is coming people save more and spend less as they do not feel very confident
• Also affected by interest rates → when IR went up, people save more and VV
• For investment → interest rates increasing, investment goes down as the cost of borrowing increases
• When confidence is high, investment goes up
  Politics → left leaning and right leaning have different ideas on government spending and involvement

Question 10

exchange rates and I and W into economy

Answer 10

• Exchange rates
• Strong pound, imports cheap and exports are expensive
• Weak pounds, imports expensive and exports cheap

Question 11

macro objectives of the gov

Answer 11

• Sustainable growth
• Low unemployment
• Low inflation/stable prices
• Trade balance, balance of payments (exports-imports)

Question 12

aggregate demand (what makes it up)

Answer 12

Aggregate demand = is the sum total of demand from all source in the economy
- Consumption: total household spending on goods and services
- Investment: spending on capital assets that will generate income in the future
- Government expenditure: public spending, health education, welfare, defense
- Exports - importas: balance of trade

Question 13

aggregate supply and AS/AD graph

Answer 13

Aggregate supply = sum total of supply from all sources in the economy
- AD curve is a demand curve
- AS is a curve that will become perfectly inelastic as there is a fixed capacity output of labour
- As Curve is L-Shaped because as the economy approaches full employment, skills shortages etc increase → it flattens bc there is a limited amount of employment
- Curves as it approaches as it demonstrates how resource imports become scarcer
costs of labour etc → trying to make their job more attractive with a higher wage
- Eventually, the wages all reach a similar level and it become perfectly inelastic

Question 14

AS/AD diagrams in a boom

Answer 14

AD increases
- Increased confidence, increased investment and consumer spending → more confidence about future
- Increase in income increases consumer spending
- Lower taxes means more consumption and investment
- Lower interest rates → consumer spending increases and investment increases ad cheaper to borrow

• Economic growth is achieved from Ye → Ye1 as unemployment is lowered (smaller distance from Ye1 to Yf)
• It depends: who benefits from these tax cuts, where do we make these tax cuts
• However: demand pull inflation as supply has not increased with AD
• How much spare capacity is there?
• Where on the AS curve is the equilibrium
• Only get demand pull inflation if near full capacity

Question 15

AS/AD diagram in a recession

Answer 15

• As economy begins to move to recession, AD decreases
• Confidence falls
• Spending falls
• Firms invest less
• AD decreases, shifts to the left
• Economy gets smaller and unemployment increases → bad for macro objectives
• As demand decreases, demand pull inflation decreases → good for macro objectives

To balance macro objectives:
- Trade off of MO
- Often unemployment and inflation

Question 16

how to increase full capacity output

Answer 16

Full capacity output can be increased by
- New tech that increase efficiency
- Investment and capital assets
- Increase in available resources