Circular Flow Of Income ( 2 )

Question 1

When is an economy in equilibrium?

Answer 1

• When withdrawals and injections are equal.

* An economy is in equilibrium when the rate of injections = the rate of withdrawals from the circular flow

Question 2

What happens when injections exceed leakages?

Answer 2

• Expenditure is greater than output, so firms will increase output.
• National output, income and expenditure will all incraese

Question 3

What happens leakages exceed injections?

Answer 3

• Output is greater than expenditure, so firms will reduce output, as a result national output income and expenditure will decrease.

Question 4

What is the formula for an economy in equilibrium?

Answer 4

Leakages = Injections

Question 5

What occurs when there are net injections into an economy?

Answer 5

There will be an expansion of national output

Question 6

What occurs when there are net leakages from an economy?

Answer 6

There will be a contraction of production, national output decreases.

Question 7

What is the multiplier effect?

Answer 7

• Ratio of rise in national income to the initial rise in AD.
• Number of times a rise in national income is larger than the rise in the initial injection of AD, which leads to the rise in national income.

Question 8

When does the multiplier effect occur?

Answer 8

• Effect occurs when there is new demand in an economy.
• This leads to an injection of more income into the circular flow of income, which leads to economic growth, more jobs, higher average incomes, greater spending and as a result more income is created.

Question 9

What does the size of the multiplier effect depend on?

Answer 9

• Rate at which money leaks from the circular flow, the larger the leakage, the quicker the money will leave the circular flow and the smaller the multiplier effect will be.

Question 10

What is wealth?

Answer 10

Total value of all the assets owned by individuals or firms in an economy.

Question 11

What is the difference between wealth and income?

Answer 11

• Income is a flow of money.

* Wealth is a stock concept.

Question 12

What is the marginal propensity to save?

Answer 12

Proportion of any extra income that is spent on the consumption of goods and services.

Question 13

What does average propensity tell you?

Answer 13

Proportion of total national income that is spent or saved.

Question 14

What is the marginal propensity to save?

Answer 14

Proportion of extra income that is saved.

Question 15

What is the average propensity to consume?

Answer 15

Percentage of income spent on goods and services, as opposed to being saved.

Question 16

What is the average propensity to save?

Answer 16

Income that is not spent on consumer goods and services.

Question 17

What is the marginal propensity to tax?

Answer 17

Proportion of new income that is paid as taxes.

Question 18

What is marginal propensity to import?

Answer 18

Proportion of any new income that is used to import goods

Question 19

Why is MPC + MPW = 1?

Answer 19

Any extra income must be spent or withdrawn.

Question 20

How does marginal tax affect multiplier?

Answer 20

• Multiplier will be relatively big if marginal tax rates, are low.
• Low marginal tax rates means a small value for MPW, which means that the multiplier is big.

Question 21

What is the formula for the multiplier?

Answer 21

Multiplier = 1 / MPW

1 - MPC = MPW