4.10.1 - The Circular Flow of Income Flashcards
How can nations meausure the flow of new output in an economy?
- The income approach
- The output approach
- The expenditure approach
What is the income approach?
Sums the factor incomes of each of the factors of production.
What is the output approach?
Adds up the ‘value added’ by each of the industries in the economy (agriculture, manufacturing and services)
What is the expenditure approach?
Sums consumption, investment, government expenditure, and exports - imports.
What are the assumptions made within the simple circular flow model?
There are two agents in the economy - households and firms.
How does the simple circular flow model look?
What are the issues within the simple circular flow model?
Assumes that all income received by households is spent on consumption.
Assumes that there are no other economy agents in the economy. (Assumes it is a closed economy with no government sector)
How is the simple circular flow model refined?
What is the equilibrium national income?
The level of income at which withdrawals from the circular flow of income equal injections into the flow.
The level of output where AD = AS.
What is the mathematical equation for when national income is at equilibrium?
When planned saving = planned investment
S = I
How can saving lead to AD falling?
Saving is a form of leakage out of the circular flow, so AD will fall, as the income given to households is not spent on consumption and new goods, leading to aggregate demand falling.
Why is it unlikely for planned saving to equal planned investment?
The motives of firms and households have very different motives, so there is no reason for planned saving to equal planned investment (i.e. the amount firms are looking to spend on capital goods) leading to a disequilibrium in national income.
What is the equation for national income being in equilibrium?
When saving + taxation + imports = investment + gov. spending + exports.
What is the Keynes think caused recession?
And why did he believe this?
Deficient AD.
If households are not putting their money in to banks to be lent by the banks to firms to invest, then the level of income and output round the economy will fall. This reduces saving, until planned saving = planned investment and equilibrium is restored at a much lower level.
