Chapter 19: The circular flow of income and aggregate demand

Question 1

Define circular flow of income

Answer 1

A model of the economy that shows the movement of goods and services between households and firms and their corresponding payments in money terms, together with the supply of factors of production

Question 2

Define leakages

Answer 2

Where money flows out of the circular flow in the form of savings, taxation and imports

Question 3

Define injections

Answer 3

Where money flows into the circular flow in the form of investment, government spending and exports

Question 4

Define gross domestic product

Answer 4

The total level of economic activity carried out in an economy during a given period

Question 5

Define consumption

Answer 5

The use of goods and services to satisfy wants - in the circular flow this is represented by consumer expenditure

Question 6

Define disposable income

Answer 6

The income that households have to devote to consumption and saving, taking into account payments of direct taxes and transfer payments

Question 7

Define rate of interest

Answer 7

The cost of borrowing and the reward for lending

Question 8

Define consumption function

Answer 8

The relationship between consumer expenditure and disposable income - its position depends upon other factors that affect how much households spend on consumer expenditure

Question 9

Define investment

Answer 9

In the circular flow, expenditure undertaken by firms to add to the capital stock

Question 10

Define aggregate demand

Answer 10

The relationship between the level of aggregate demand and the overall price level - it shows planned expenditure at any given possible overall price level

Question 11

Define wealth effect

Answer 11

An effect by which an increase in the average price level reduces purchasing power and therefore the quantity of of real output demanded