Economic Theory

Question 1

What are the 4 sectors of the circular flow of income

Answer 1

Households, Businesses, Government, External sector

Question 2

What does the circular flow of income demonstrate

Answer 2

The circular flow model demonstrates how money moves from producers to households and back again in an endless loop.

Question 3

What do households receive from firms in a circular flow income

Answer 3

Wages, Dividends

Question 4

What do firms receive from households

Answer 4

Purchases of goods and services

Question 5

What does the government give and receive in the circular flow of income

Answer 5

The government receives taxes and gives social transfers to house holds and government spending to firms

Question 6

What does the external sector give and receive

Answer 6

The external sector is different country’s and they give us exports and we give them imports

Question 7

Why is Y=O=E equal

Answer 7

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

Question 7

Why is Y=O=E equal

Answer 7

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.

Question 8

What is Y

Answer 8

National Income - The income paid by firms to households

Question 9

What is O

Answer 9

National output - the output of firms (value of what they produce)

Question 10

What is E

Answer 10

The National expenditure - Spending by households on the goods and service produced by firms

Question 11

What is an injection

Answer 11

Income / money introduced into the economy

Question 12

What are the 3 injections in the economy

Answer 12

Exports, Investment and Government spending

Question 13

What are withdrawals

Answer 13

Money leaving / leaking out the economy

Question 14

What are the 3 withdrawals in the economy

Answer 14

Imports, Taxation and Savings

Question 15

How do injections affect the equilibrium for income

Answer 15

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.

Question 16

How do Withdrawals affect the equilibrium for income

Answer 16

Withdrawals will lower the equilibrium level of income as withdrawals lower GDP this means lower incomes as there is less money to spend.

Question 17

What is the multiplier effect

Answer 17

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.

Question 18

What are the units of AD

Answer 18

Consumption, Investment, Government spending and exports - imports
AD = C + I + G + (X-M)

Question 19

What is Aggregate demand

Answer 19

Aggregate demand is the sum of all expenditure in the economy over a period of time. (GDP)

Question 20

What causes a movement along the AD curve

Answer 20

A change in price level

Question 21

What causes a shift in the AD curve

Answer 21

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.

Question 22

Explain the consumption component

Answer 22

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

Question 23

What are the factors of consumption

Answer 23

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.

Question 24

Explain the Investment component

Answer 24

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.

Question 25

What are the 5 factors of investment

Answer 25

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.

Question 26

Explain the Government spending component

Answer 26

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.

Question 27

What are factors of government spending

Answer 27

Increase in taxes, more attraction and interest to the country and state of economy slump/ boom.

Question 28

Explain the Net export component

Answer 28

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.

Question 29

What are the factors of Net exports

Answer 29

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.

Question 30

What is an import

Answer 30

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.

Question 31

What is the difference between a surplus in the balance of payments to a deficit in the balance of payments

Answer 31

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

Question 32

What are net exports

Answer 32

Net exports is the difference between exports and imports in a period.

Question 33

Why does the AD curve slope downwards from left to right

Answer 33

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.

Question 34

What is the Keynesian long supply curve

Answer 34

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.

Question 35

Why at the later end of an economic cycle there is an increase in price level

Answer 35

There is inflationary pressure building up as prices increase as less unemployment so demand rises

Question 36

What are the factors of AS

Answer 36

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

Question 37

How do the AD and AS curves interact to determine the equilibrium

Answer 37

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

Question 38

What are the two types of supply side policies

Answer 38

Free market orientated and Interventionist

Question 39

What are the free market oriented policy’s

Answer 39

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

Question 40

What are the interventionist policies

Answer 40

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

Question 41

What does investment increase in the economy (macro)

Answer 41

Increases productivity, competitiveness, economic growth, employment and trade balance

Question 42

What does exports improve in the economy (macro)

Answer 42

Help pay for imports, reduces trade deficit, employment effects and economic growth

Question 43

How does government spending improve the economy (macro)

Answer 43

G spending helps correct market failure and reduces inequality and helps support the private sector (education, training, infrastructure)