41: Circular Flow of Income

Question 1

3 types of Injections

Answer 1

Investment (I)
Exports (X)
Government Spending (G)

Question 2

3 types of withdrawals

Answer 2

Savings (S)
Taxation (T)
Import (M)

Question 3

Multiplier effect

Answer 3

When an injection into circular flow of income leads to greater proportional increase in AD

Question 4

How to use multiplier/ effect of AD on national income

Answer 4

multiplier x injections = total increase in GDP

Question 5

Multiplier formula

Answer 5

1/mps or 1/(1-mpc)

Question 6

Define MPS and MPC

Answer 6

MPS: proportion of extra income that is saved (change in saving/change in income)
MPC: proportion of extra income that is consumed (change in consumption/ change in income)

Question 7

Define Marginal Rate of Taxation

Answer 7

Proportion of extra income that is taxed

Question 8

Define Marginal Propensity of Import (MPM)

Answer 8

Proportion of extra income spent on import

Question 9

National Income Equilibrium

Answer 9

2 sector (I=S)
3 sector (I+G=S+T)
4 sector (I+G+X=S+T+M)
2/3 - closed economy
4 - open economy

Question 10

Multiplier formula for 2/3/4 sector

Answer 10

only include injections
2 sector 1/mps
3 sector 1/(mps+mrt)
4 sector 1/(mps+mrt+mpm)

Question 11

Define AE

Answer 11

Total amount spent at different level of GDP in a given time period.

Question 12

National Income Determination through?

Answer 12

1. AD=AS
2. AE=Real GDP

Question 13

Components of AE

Answer 13

Consumption
Investment
Government spending
Net exports

Question 14

Consumption function

Answer 14

c = a + bY
*a= autonomous spending
*b= MPC
*Y= disposable/ after tax income

Question 15

Savings function

Answer 15

s= -a + sY
*a= autonomous saving (zero income, dissavings, negative sign)
*s= MPS
*Y= disposable income

Question 16

Factors increasing consumption

Answer 16

1. increase wealth
2. lower IR
3. high confidence
4. more credit available (easy to borrow and spend)
5. distribution of wealth to lower income

Question 17

Do low income have higher MPC than high income?

Answer 17

Yes

Question 18

2 type of investment

Answer 18

1. Autonomous - investment made independent of income
2. Induced - investment made in response to change in income

Question 19

Factors increasing investment

Answer 19

1. consumer demand increase
2. IR decrease
3. Expectations positive
4. Gov policy (deregulation)
5. Technology increase
6. Cost of capital good decrease

Question 20

Accelerator effect

Answer 20

Investment expenditure increase when AD/ National Income increase

Question 21

Will firms always respond to changes in demand by increasing investment?

Answer 21

• if firms can meet rising demand by maximising capacity, investment is less likely to happen
• if technology improves, capital output ratio may increase and reduce investment
  -if capital good are working to capacity, firms will invest to expand capacity

Question 22

Factors increasing gov spending

Answer 22

1. Tax revenue increase
2. Political priorities ( expand military - increase spending,
   rising national debt - decrease spending)
3. Gov policy
4. Changing demographics (immigrants increase, spending increase)

Question 23

Factors increase net export

Answer 23

1. Depreciation of ER
2. Increase competitiveness of g/s
3. Increasing purchasing power of other countries
4. YED elastic

Question 24

Inflationary gap and deflationary gap

Answer 24

inflationary gap : Excess AE over potential output
(AE > Real GDP)
deflationary gap : Shortage of AE so potential output not reached
(AE < Real GDP)