Circular flow of income and GDP

Question 1

Describe the real activity of households and firms

Answer 1

Households provide factors of production and firms use these to provide goods and services to households (cycle repeats)

Question 2

In terms of monetary activity, what do houses and firms provide directly to each other

Answer 2

Houses spend money on goods and services and firms pay wages, rent, interest and profits to households

Question 3

Describe how savings and investment come into the circular flow of income

Answer 3

• households don’t spend all of their money now, they save their money as well
• firms don’t spend all of their money for production now, they make capital investments

Question 3

Describe how the financial sector (e.g. banks) plays a role in savings and investment

Answer 3

• Connects household saving and capital investment from firms
• This is because households save money in a bank and this money is recycled to firms when they need it for investment

Question 4

Why are savings a withdrawal

Answer 4

It is a leakage out of the circular flow of income (goes to bank instead of firms)

Question 5

Why are investments an injection

Answer 5

Causes new source of money to enter the circular flow of income (going from banks to firms)

Question 6

Describe the role that the government plays in the circular flow of income

Answer 6

• Taxes households and firms, removing income (leakage)
• Uses tax money for government spending on households and firms, increasing income (injection)

Question 7

What role does the rest of the world play in the circular flow of income

Answer 7

• They import from the circular flow (withdrawal)
• they export into the circular flow (injection)

Question 8

What are the 3 types of withdrawal

Answer 8

Savings
Tax
Imports

Question 9

What are the 3 types of injections

Answer 9

Investment
Government spending
Exports

Question 10

What happens if injection is higher than withdrawals

Answer 10

National income will increase to a higher equilibrium

(and vice versa)

Question 11

What is the difference between GDP, GNP and GNI

Answer 11

They are measuring the same thing but:
- GDP is the total output produced in the UK

• GNP adds the net investment of assets held overseas

-National income is GNP minus depreciation of capital

Question 12

Why is real GDP per capita more accurate than GDP

Answer 12

Takes in to account inflation and changes in the population
e.g. china and india have a high GDP but low GDP per capita so the average person is poorer than GDP suggests

Question 13

Why is real GDP per capita used to measure standard of living

Answer 13

• If the average person is richer, they can consume more, so they gain more utility per year they enjoy
• Also reduces poverty
• Also increases tax revenue so increases benefit from public goods e.g. healthcare

Question 14

What are the negatives of using real GDP per capita to measure standard of living?

Answer 14

1) Only takes into the account an increase in quantity of goods produced, not quality
2) Doesn’t take into account the distribution of the increase in income, people might be getting poorer
3) Doesn’t take into account negative environmental externalities
4) Ignores what specific goods and services are produced

Question 15

What is another measure of standard of living that may be more accurate

Answer 15

HDI takes into account real GDP per capita, life expectancy and education