Circular Flow Of Income

Question 1

What is an economy made up of?

Answer 1

Households and Firms

Question 2

What role do firms play in an economy?

Answer 2

• Firms supply goods and services that make up the national output ( provided to households ).

Question 3

What role do households play in an economy?

Answer 3

• Households supply firms with the factors of production ( labour, land and capital ), that firms use to produce the national output.

Question 4

What is national income?

Answer 4

• Money paid to households by firms in return for provision of the factors of production used in producing goods and services.
• Monetary value of the flow of output of goods and services produced in an economy over a period of time.

Question 5

What is national expenditure?

Answer 5

• Expenditure by households using the income paid by firms on goods and services created by the firms.
• Total level of expenditure in an economy

Question 6

What is the formula for output/income/expenditure?

Answer 6

National output = National Income = National Expenditure

Question 7

What are the two flows?

Answer 7

• Physical Flows

* Monetary Flows

Question 8

What is a physical flow?

Answer 8

The flow of a good or service ( or factors of production such as land, labour and capital ).

Question 9

What is a monetary flow?

Answer 9

The flow of money, which could be in the form of taxes or from consumption.

Question 10

What does the circular flow suggest about national output?

Answer 10

As long as households keep spending what they earn, and firms keep using their revenues to produce more goods using the same inputs, then national output and national income won’t change.

Question 11

What is national income in an economy’s circular flow of income affected by?

Answer 11

• Injections

* Withdrawals

Question 12

What is an injection?

Answer 12

• Money which enters the economy/Inflow into the circular flow of income
• Typically come in the form of exports, investments and government spending.

Question 13

What is a leakage?

Answer 13

• Money which leaves the economy/Outflow from the circular flow of income
• Typically occur via saving, taxes and imports.

Question 14

When does the economy reach a state of equilibrium?

Answer 14

When the rate of leakages = rate of injections.

Question 15

What is meant by the circular flow of income

Answer 15

• Economic model depicting how money flows through the economy:
• Money flows to workers in the form of wages, money flows back to firms in exchange for goods and services.

Question 16

What effect will injections being greater than withdrawals have on the economy?

Answer 16

• Expenditure is greater than output
• Firms will as a result increase output
• National output, income and expenditure will all increase.

Question 17

What effect will withdrawals from the circular flow being greater than injections have?

Answer 17

• Output is greater than expenditure
• Firms will reduce output
• National output, income and expenditure will decrease.

Question 18

What occurs when there are net injections?

Answer 18

• Expansion of national output

Question 19

What occurs when there are net leakages?

Answer 19

• Contraction of production

* Decreasing output

Question 20

What is the multiplier effect?

Answer 20

• An effect in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.
• How an initial increase in AD leads to an even bigger increase in national income.

Question 21

What occurs in the multiplier effect?

Answer 21

When an injection is made into the circular flow, the actual change in the national income is greater than the initial injection, this is the multiplier effect.

Question 22

When does the multiplier effect occur?

Answer 22

Multiplier effect occurs when there is a new demand in an economy, leading an injection of more income into the circular flow, which leads to economic growth.

Question 23

What is the multiplier ratio?

Answer 23

• The ratio of the rise in national income to the initial rise in AD.
• The number of times a rise in national income is larger than the rise in initial injection of AD, which led to the rise in national income.

Question 24

What is the size of the multiplier dependent on?

Answer 24

• Rate at which money leaks from the circular flow.

* Larger the leakages, the smaller the multiplier effect will be.