4.2.2.1 the circular flow of income

Question 1

what is the circular flow of income?

Answer 1

an economic model showing the:
- flow of goods and services
- factors of production
- payments between households and firms
within a closed economy

Question 2

how do households contribute to the circular flow of income?

Answer 2

• they own the wealth of the nation
  -> land / labour / capital / enterprise
• they supply these factors in return for an income
  -> rent / wages / profits / dividends
• then they use this income to buy goods and services produced by firms
• this creates a circular flow of income

Question 3

what are the model’s assumptions?

Answer 3

• households spend all their income on goods and services
• firms spend all their income on factors of production
• there’s no government
• there’s no foreign trade

Question 4

what is wealth?

Answer 4

• a stock concept
• assets owned
  eg) buildings / land / savings / shares
• human wealth
  eg) skills / education

Question 5

what is income?

Answer 5

• is a flow concept
• money generated from wealth
  eg) wages / rent / interest

as income flows from the stock of assets,
a nations income and wealth are directly correlated

Question 6

what happens if we use our income to invest in capital goods today?

Answer 6

• means that we increase our productive capacity
• giving us greater stock of wealth in the future
• an increase in capital goods will shift PPF outwards
• this economic growth leads to higher income in the future

Question 7

an increase in income will have a direct impact on wealth, providing the finance for investment

what does this cause?

Answer 7

• investing in productive capacity of the economy increases the stock of physical assets
  -> therefore increasing wealth
• this will lead to economic growth and higher income in the future
• this will allow us to further increase our stock of wealth

Question 8

what are injections?

Answer 8

add money into the circular flow of income

• exports = provide injection of more money
• investment = business may invest
• government spending = if it increases it causes an injection into the economy

Question 9

what are withdrawals?

Answer 9

remove money from the circular flow

• imports = more imports mean more money out
• taxation = reduces disposable income

-savings = removes money from circulation

Question 10

what happens when there’s more injections than withdrawals?

Answer 10

growth!!

• expenditure will exceed the planned level of output
• firms will increase output
• output and national income will increase
• expenditure will increase

Question 11

what happens when withdrawals are higher than injections?

Answer 11

shrinking!!

• output will exceed expenditure
• firms will reduce output
• national income and expenditure will decrease

Question 12

when is the economy in macroeconomic equilibrium?
when does disequilibrium occur?

Answer 12

• injections = withdrawals
• occurs when the plans of firms and households differ

Question 13

what happens in equilibrium?

Answer 13

• there’s no tendency to change
• the economy stays the same size
• government wants sustainability

Question 14

what is full employment income?

Answer 14

• the total output of an economy when unemployment is minimised or is at the government target

Question 15

what happens if there are net injections

Answer 15

there will be an expansion of national output

Question 16

what happens if there are net withdrawals

Answer 16

there will be a contraction of production, so output decreases