Circular flow and the multiplier effect Flashcards
What is the circular flow?
An economic model showing the flow of goods and services, the factors of production and their payments between households and firms within an economy
What do all the goods and services produced in an economy make up?
The national output
Why does National output = national income = national expenditure
Firms produce goods and services - National output
Households provide the factors of production, in return firms pay households income - National Income
Households spend the money from national income - National expenditure
The national output, national income and national expenditure can be shown on a diagram, draw it
See book
- Households on top, firms on bottom
- Physical flows in the middle showing factors and goods/services
- Monetary flows on the sides showing income and expenditure
What are physical flows?
Shows ‘real things’ i.e goods/services + Land, labour and capital - shown by straight arrows
What are monetary flows?
Shows the money that pays for the ‘physical things’’ - Shown by curved arrow
What can the circular flow be affected by?
Injections and withdrawals (aka leakages)
This means money into or out of the circular flow of income
Example of injections and withdrawals into or out of the circular flow of income
Injections: Exports, investment and government spending
Withdrawals: Imports,, savings and taxes
Draw the revised circular flow including injections and withdrawals
n/a
What is it called when injections with withdrawals are equal?
The economy is in equilibrium
What is the multiplier effect?
When an injection is made into the circular flow, the actual change in the national income is greater than the initial injection
What does the size of the multiplier effect depend upon?
The rate at which money leaks from the circular flow - e.g.. the bigger the leakages/withdrawals, the quicker money will leave the circular flow and the smaller the multiplier effect will be.
So, if lots of money is being spent on imports (or used as savings or tax) then the multiplier effect will be quite small because the injection will quickly leak out of the circular flow
What is the equation for calculating the multiplier effect?
K = Change in Y / Change in J
K = The multiplier
Y = Real National Income
J = Injections
Example calculation?
If the government injected £500m into the circular flow and the resulting change in real Income was £2bn, what is the multiplier?
K = 2bn/500m
K = 2/0.5
Therefore, the multiplier is 4.
What is the difference between a positive multiplier and a negative multiplier?
Initial withdrawal or leakage from the circular flow leads to a greater final decrease in real GDP
Initial injection in into the circular flow leads to a greater final increase in real GDP
