Circular Flow of Income

Question 1

In a closed economy, what are the physical and monetary flows between firms and households.

Answer 1

Physcial - Households give FoPs, firms give G/S.

Monetary - Households sped money on G/S, firms give income (rent, wages, interest, profits)

Question 2

In an open economy, what are the 3 withdrawals from households?

Answer 2

Savings (to banks), Taxes (to the gvt), Imports (to the international sector)

S, T, M

Question 3

In an open economy, what are the 3 injections received by firms?

Answer 3

Investment (loans from banks), Gvt spending (from tax revenue), Exports (from international sector)

I, G, X

Question 4

How are withdrawals endogenous?

Answer 4

They depend on the level of income in the economy. The more people earn, the more they save, pay in tax and spend on imports.

Question 5

How are injections exogenous?

Answer 5

They don’t depend on the level of income in the economy. Income doesn’t affect how much the gvt spends.

Question 6

What is the multiplier effect?

Answer 6

Injections into the circular flow of income have a bigger effect on national income than the initial investment.

The size of the multiplier depends on level of withdrawals. (S, T, M)

Question 7

How do you calculate marginal propensities?

Answer 7

Change in the consumption/ withdrawal divided by change in income.

Eg. MPS = change in savings/ change in income

Question 8

What makes up the marginal propensity to withdraw and how does it relate to the marginal propensity to consume?

Answer 8

MPW = MPS + MPT + MPM

MPC + MPW = 1

Question 9

How do you find the multiplier from marginal propensities?

Answer 9

Multiplier = 1/ MPW

MPW = 1 - MPC

Question 10

Define a positive and negative multiplier.

Answer 10

Positive multiplier - when an increase in injections results in a bigger increase in national income.

Negative multiplier - when a decrease in injections results in a bigger decrease in national income.