circular flow of income Flashcards
What is the circular flow of income?
The circular flow of income shows the economy as a simple model where the households own all the factors of production-‐ land, labour, capital and enterprise-‐ and the firms produce goods.
How does money move? (according to the circular flow)
Money moves from households to firms for the exchange of goods and services; and money moves back to households as payment for the use of the factors of production in the form of rent, wages, interest and profit.
Money circulates back and forth, and the more households spend the more firms produce.
What are withdrawals?
Withdrawals from the circular flow is money which leaves the flow, and does not flow back from households to firms.
What are the 3 withdrawals?
Savings, Taxation, Imports (STM)
What are injections?
Injections into the circular flow is consumption which does not come from households.
What are the 3 injections?
Investment, Government Spending, Exports (IGX)
What are the conditions of injections and withdrawals?
If all the injections equal leakages, the economy is in equilibrium.
If injections are greater than withdrawals, there will be economic growth.
If withdrawals are greater than injections, there will be negative economic growth.
What is the likely correlation between income and wealth?
Wealth is the sum of all assets in an economy-‐ it is a stock concept.
Income is the amount of money earned during a period-‐ it is a flow concept.
Is there a perfect correlation?
Countries with high levels of wealth tend to produce high levels of income. This is because the assets (wealth) can be used to produce an output which can produce an income.
National income tends to be correlated with national wealth, but because wealth can be mismanaged, the correlation is not perfect.
What is wealth?
Wealth is a stock concept so does not have a direct impact on the circular flow of income, but changes in wealth are likely to have an effect on income and spending. For example, if you house becomes worth more, you will feel ‘richer’ and spend more, which will lead to more money going into the circular flow. This in turn increases income in the economy. This effect is called the wealth effect.
What is the wealth effect?
The wealth effect is the idea that when a household’s wealth increases, they feel more confident so spend more, allowing more money to enter the circular flow of income.
