Circular Flow of Income

Question 1

What does macroeconomics study?

Answer 1

Macroeconomics studies the economy as a whole.

Question 2

What does Circular Flow of Income Model describe

Answer 2

It aims to explain how resources, goods, services, income, and expenditure circulate within an economy.

Question 2

What are the focuses of macroeconomics?

Answer 2

Macroeconomics focuses on understanding why the economy grows and why economic activity fluctuates over time. It concerns itself with the business cycle, economic growth, inflation, unemployment, and government policies.

Question 2

How does the model divide the economy into sectors?

Answer 2

Household sector
Firms sector
Financial sector
Government sector
Overseas sector

Question 3

What are some assumptions of the model?

Answer 3

Households own productive resources (land, labor, capital, and overseas resources) and buy final goods and services.

Firms employ resources and produce all goods and services.

All output is sold to households, who spend all their income, implying no saving, government sector, or overseas trade.

Question 4

What happens in the factor market?

Answer 4

In the factor market, households receive income from the resources they supply to firms for use in the production process.

Question 5

What happens in the product market?

Answer 5

In the product market, households spend their income in exchange for goods and services produced by the firms sector.

Question 6

What role does the financial sector play in the economy?

Answer 6

pooling surplus funds from savers to create a pool of funds for firms.

Question 7

How are savings and investment viewed in the circular flow model?

Answer 7

Savings are considered a leakage, while investment is an injection into the circular flow of income.

Question 8

What is the role of the government sector in the circular flow of income?

Answer 8

The government sector collects taxes (leakage) from households and injects money back into the economy through government spending.

Question 9

What is the role of the Reserve Bank of Australia in the financial sector?

Answer 9

controls the cash rate, which influences interest rates, impacting spending, savings, and investment loans.

Question 10

How does government spending categorize its expenditure?

Answer 10

current expenditure (on goods and services like wages, fuel, and stationery) and capital expenditure (on infrastructure like schools, roads, and hospitals).

Question 11

What are examples of government provision in the economy?

Answer 11

Government provides collective goods and services, buys goods and services from businesses, and offers social welfare programs like pensions and child care allowances.

Question 12

What is the role of the government sector in the economy?

Answer 12

making laws and regulations, managing job creation, collecting taxes, and spending money on collective wants for the Australian community.

Question 12

How does the government finance its spending if tax revenue is insufficient?

Answer 12

If tax revenue is insufficient, the government can sell public assets or borrow money from other countries

Question 12

What do leakages and injections represent in the circular flow of income

Answer 12

leakages represent money going out of the economy (like taxes, savings, and imports), while injections represent money coming into the economy (such as consumption, government spending, and investment loans).

Question 13

What role does the overseas sector play in the economy?

Answer 13

The overseas sector involves households and firms spending on imports and earning income from exports. Imports are a leakage, while exports are an injection into the economy.

Question 14

How do leakages and injections affect the flow of money in the economy?

Answer 14

Leakages reduce the flow of money, while injections increase it, directly contributing to economic growth.

Question 15

What does macroeconomic equilibrium entail?

Answer 15

Macroconomic equilibrium states that at any point in time, the total value of output (O) must equal the total value of income (Y), which must equal the total value of expenditure (E).

Question 16

What is the condition for macroeconomic equilibrium?

Answer 16

The condition for macroeconomic equilibrium is represented by the equation:
∑𝑂=∑𝑌=∑𝐸
∑O=∑Y=∑E

Question 17

What happens when equilibrium occurs in the economy?

Answer 17

there is no tendency for the level of income in the economy to change, indicating system is in balance.

Question 18

What is the condition for full circular flow equilibrium including leakages and injections?

Answer 18

For equilibrium in the full circular flow model, the sum of withdrawals (S + T + M) must equal the sum of injections (I + G + X):
𝑆+t+𝑀=𝐼+𝐺+𝑋
S+T+M=I+G+X

Question 19

How do firms and households respond to disequilibrium?

Answer 19

Firms react to lower spending by reducing production and employment, leading to lower income for households, which in turn decreases consumption and savings until a new equilibrium is reached.

Question 20

What happens in disequilibrium?

Answer 20

In disequilibrium, there is an imbalance between leakages and injections. If savings exceed investment (S > I), the flow of income in the economy contracts, leading to unsold inventories and adjustments in production and consumption.

Question 21

What happens to the economy after an initial increase in investment?

Answer 21

The economy will continue to expand until a new equilibrium is reached, where income and savings equal investment.

Question 22

What is Gross Domestic Product (GDP)?

Answer 22

GDP measures the total market value of all final goods and services produced within a country during a specific period.

Question 23

How is GDP defined by the ABS?

Answer 23

‘total market value of goods and services produced in Australia after deducting the cost of goods and services used up in the process of production’.

Question 24

Why do we only count the final value of goods and services in GDP?

Answer 24

To avoid double counting the value of intermediate goods.

Question 25

What does each letter represent in the GDP formula?

Answer 25

C = consumption expenditure, I = investment expenditure, G = government expenditure, X = exports, M = imports.

Question 25

How much of the final value is counted in GDP

Answer 25

For example a farmer grows wheat and sells it to a flour mill for $10,000. The mill produces flour and sells it to the grocery chain for $20,000. The supermarket sells the flour to consumers for $30,000.Only the final value of $30,000 is counted in GDP.

Question 25

What are the components of the expenditure method of measuring GDP?

Answer 25

GDP = C + I + G + (X - M)

Question 25

What is consumption expenditure?

Answer 25

he market value of all goods and services purchased by households, including both durable and non-durable goods.