Economic Theory Flashcards
What are the 4 sectors of the circular flow of income
Households, Businesses, Government, External sector
What does the circular flow of income demonstrate
The circular flow model demonstrates how money moves from producers to households and back again in an endless loop.
What do households receive from firms in a circular flow income
Wages, Dividends
What do firms receive from households
Purchases of goods and services
What does the government give and receive in the circular flow of income
The government receives taxes and gives social transfers to house holds and government spending to firms
What does the external sector give and receive
The external sector is different country’s and they give us exports and we give them imports
Why is Y=O=E equal
National income (Y) equals national output (O) and national expenditure (E) as a change in Y changes national expenditure and a change in O will change national income
Why is Y=O=E equal
First of all This is the value of consumer goods and services demanded in a particular period of time. Consumer spending is a function of income. This means that as income changes then so does consumer spending.
What is Y
National Income - The income paid by firms to households
What is O
National output - the output of firms (value of what they produce)
What is E
The National expenditure - Spending by households on the goods and service produced by firms
What is an injection
Income / money introduced into the economy
What are the 3 injections in the economy
Exports, Investment and Government spending
What are withdrawals
Money leaving / leaking out the economy
What are the 3 withdrawals in the economy
Imports, Taxation and Savings
How do injections affect the equilibrium for income
Changes In injections and withdrawals can affect the equilibrium level of income as an increase In injections cause the economy to grow as more money circulating in the economy increases income, decreases unemployment and consumption increase which increases the equilibrium level of income.
How do Withdrawals affect the equilibrium for income
Withdrawals will lower the equilibrium level of income as withdrawals lower GDP this means lower incomes as there is less money to spend.
What is the multiplier effect
The multiplier effect is a process by which an injection into the circular flow of income creates a change in size of national income that’s bigger than the initial injection.
What are the units of AD
Consumption, Investment, Government spending and exports - imports
AD = C + I + G + (X-M)
What is Aggregate demand
Aggregate demand is the sum of all expenditure in the economy over a period of time. (GDP)
What causes a movement along the AD curve
A change in price level
What causes a shift in the AD curve
a shift in the curve will be be because of a change in other factors except from price changes, these factors being the AD components.
Explain the consumption component
Consumption is spending by households on goods & services. Consumer spending is biggest single component of aggregate demand in the UK and is around 60% of GDP in the UK
What are the factors of consumption
Level of and changes in employment
General state of consumer confidence, An increase in consumer confidence determines the willingness of consumers to spend.
Interest rates – Interest rates cause a change in consumption as Higher interest rates make saving more of an incentive as they gain more and they are less likely to borrow as it is more expensive.
Taxation Levels – Tax increases decrease consumption as consumer have less disposable income, A reduction in tax will increase consumption.
Consumer expectations - Consumption could increase if there is an expectation of growth in income or household income.
Explain the Investment component
Investment is when firms spend money back into the business and expand it, firms will mainly invest into capital goods (machinery) because investing into capital goods can reduce costs and improve productivity and in the long run create more profit. Investment is around 15% of GDP in the UK. Also investment increases AS.
What are the 5 factors of investment
Interest rates when interest rates are high there is a less incentive to invest as a higher interest to pay back so riskier.
Economic growth If there is growth more likely consumers to spend
Confidence - Investment is riskier than saving. Firms will only invest if they are confident about future costs, demand and economic prospects.
Inflation - In the long-term, inflation rates can have an influence on investment. High and variable inflation tends to create more uncertainty and confusion
Technology - Long-term changes in technology can influence the attractiveness of investment, if huge changes in technology.
Explain the Government spending component
The government spends money they receive from tax revenue and they spend the money on public services, health, defence and education, government spending is an injection to the economy, AD will shift to the right.
What are factors of government spending
Increase in taxes, more attraction and interest to the country and state of economy slump/ boom.
Explain the Net export component
exporting is when we export materials from our own country to another country for an exchange for money, also if tourists abroad buy items at our country it will be classed as an export. Exports will cause an increase in AD.
What are the factors of Net exports
Factors of exports and imports is Exchange rates, having a cheaper currency may increase exports but an increase in the currency will increase imports, also foreign incomes rise there would be an increase in exports.
What is an import
Imports is when our country imports goods from other countries for an exchange for money. This will decrease AD as it is a leakage from our economy.
What is the difference between a surplus in the balance of payments to a deficit in the balance of payments
If there are more exports than imports we have a surplus of balance of payments and a deficit of balance of payments is when there is larger amount of imports than exports
What are net exports
Net exports is the difference between exports and imports in a period.
Why does the AD curve slope downwards from left to right
Generally at high price quantity demand is low vice Verda because
Increased spending power - At a lower price level, consumers are likely to have higher disposable income and therefore spend more.
Lower interest rates. At a lower price level, interest rates usually fall, and this causes higher aggregate demand.
What is the Keynesian long supply curve
The Keynesian aggregate supply curve is non-linear where the elasticity of aggregate supply is dependent in part on the level of spare productive capacity at different stages of a nation’s economic cycle.
Why at the later end of an economic cycle there is an increase in price level
There is inflationary pressure building up as prices increase as less unemployment so demand rises
What are the factors of AS
Increase in productivity can be achieved by better technology, better efficiency in production, more quantity of labour (more employment) and better quality as this increases customer satisfaction, higher wagesAlso supply side policy’s increase AS
How do the AD and AS curves interact to determine the equilibrium
equilibrium is the price-quantity pair where the quantity demanded is equal to the quantity supplied. It is represented on the AS-AD model where the demand and supply curves intersect
What are the two types of supply side policies
Free market orientated and Interventionist
What are the free market oriented policy’s
Privatisation - Selling of state owned assets to private sector increases incentive
Deregulation - allow new firms to enter markets
Income tax cuts - greater incentive to work longer hours
Remove regulation/red tape - make it easier to build more factories and houses
Free-trade agreements - reduce tariff barriers and other obstacles to trade
Reduce welfare benefits - create more incentive to get a job
What are the interventionist policies
Public sector investment - invest into infrastructure improve transport and reduce costs
Education - Increase findings to schools and universities - improved future labour productivity
Vocational training - Gov scheme to provide new skills to people who don’t have or lost jobs
Health spending - public spending on health can reduce hours lost to Ill-health
What does investment increase in the economy (macro)
Increases productivity, competitiveness, economic growth, employment and trade balance
What does exports improve in the economy (macro)
Help pay for imports, reduces trade deficit, employment effects and economic growth
How does government spending improve the economy (macro)
G spending helps correct market failure and reduces inequality and helps support the private sector (education, training, infrastructure)
