Lesson 3 - The Circular Flow Of Income

Question 1

What is actual growth?

Answer 1

• What is happening now?
• short run
• demand side

Question 2

What is trend growth?

Answer 2

• average over time
• supply side
• long run growth

Question 3

Draw and name the 4 parts of the economic cycle and the 2 types of output gaps

Answer 3

• Boom, recession, slump, recovery
• positive and negative output gap

Question 4

Describe a boom

Answer 4

• hot economy (AD is greater than supply)
• low unemployment
• can lead to inflation
• high imports
• hard for businesses to hire, leading to the wage prices spiral

Question 5

Describe a recession (downturn)

Answer 5

• unemployment is rising
• economy is slowing down
• investment is falling

Question 6

Define a recession

Answer 6

2 consecutive quarters of negative growth

Question 7

Describe a recovery

Answer 7

• unemployment is falling - firms start to hire again
• confidence is rising (leads to a rise in AD)

Question 8

Describe a slump

Answer 8

• high unemployment
• low confidence, low AD (economic growth)

Question 9

Describe the link between GDP, national output, expenditure and income

Answer 9

GDP = expenditure = income = national output

Question 10

Describe the circular flow of income

Answer 10

Households to firms
- hire of factors
- payments for goods/services

Firms to households
- payment for factors
- goods/services

Question 11

What are the injections in an open economy?

Answer 11

• government spending
• exports
• investments

Question 12

What are the leakages in an open economy?

Answer 12

• imports
• taxes
• savings

Question 13

What are the 2 assumptions made in the circular flow of income?

Answer 13

• that households spend all of the income they receive
• demand and supply are in equilibrium

Question 14

What is a closed economy?

Answer 14

• no imports/exports
• no relationships with other economies

Question 15

What is the equation for macroeconomic equilibrium in the circular flow of income?

Answer 15

Taxes + savings + imports = exports + gov spending + investment
(T + S + M = X + G + I)

Question 16

What is the Keynesian approach towards a recession?

Answer 16

• if we are moving towards a recession, we need to stimulate AD by increasing gov spending and lowering taxes
• the injections will have a multiplied effect, so the national income will increase further

Question 17

What is government spending?

Answer 17

A direct injection with multiplied effects

Question 18

What are the issues with the Keynesian approach?

Answer 18

• if demand increases but LRAS doesn’t, then we experience supply constraints
• rise in costs is reflected by a rise in prices, leading to inflation (demand pull)
• leads to the economic problem - unlimited wants, scarce resources

Question 19

Give an example of when the Keynesian approach was used and explain

Answer 19

Furlough scheme:
- providing grants to firms to help them pay workers wages
- prevented high unemployment and saved the UK from a deep recession

Question 20

What is the new classical approach?

Answer 20

• allowing the free market to clear the economy (reach equilibrium)