Macro 2: Circular Flow of Income and GDP Flashcards
What is an economic agent?
An individual or company that influences an economy by producing, selling or buying goods and services or investing money.
What are the three main economic agents?
Households, firms and government
What is the role, objective/aim and incentive of households?
Role- to supply factors of production and purchase goods and services
Objectives/aims- maximise personal satisfaction
Incentives- cost changes
What is the role, objective/aim and incentive of firms?
Role- to convert factors of production into goods and services
Objectives/aims- maximise profit
Incentives- prices change
What is the role, objective/aim and incentive of government?
Role- to generate revenue to provide an essential economic framework
Objectives/aims- maximise social welfare
Incentives- votes
What is the circular flow model?
A feedback loop between households and firms. The government creates a leakage in the circular flow by imposing taxes, but also inject money through social transfers like state pension, housing benefits etc.
What is the external sector?
The UK buys imports from other countries, (M), and overseas businesses and consumers buy UK products- known as exports (X).
What is the financial sector?
It’s a way of channeling the savings of households and businesses and repackaging them in the form of loans and other forms of finance, eg. to fund business investments.
What are the 3 types of injection of extra spending into the circular flow model?
-Investment in capital goods
-Exports of goods and services
-Government spending
This inflates the value/volume of production in the economy.
What are the 3 types of leakage or withdrawal from the circular flow?
-Savings
-Imports of goods and services
-Taxation
This depresses/ deflates the level of demand and output.
When is the circular flow in balance?
When the level of injections= the level of withdrawals.
What happens when injection > leakages?
The level of national income will rise.
What happens when leakages > injection?
The level of national income will contract.
What are the three things an economist might measure when measuring the amount of economic activity in an economy?
1) Total production of goods and services
2) Total household income
3) Total expenditure
In theory the value of each one of these should be the same.
How long is the course of which an economist measures the size of an economy?
A year.
What does nominal GDP include?
Apparent increases in income and expenditure that arise merely because of inflation.
What is real GDP?
Adjusted to account for inflation.
If inflation in the economy one year has been 5% and nominal GDP has increased by 5% what happened to real GDP?
Real GDP hasn’t increased at all because the apparent increase in output is only the product of more money being spent on the same quantity of products.
How is GDP calculated?
Consumption + Interest + Government spending + (Export - Import)
What is national income?
The total monetary value of the output of goods and services within an economy over a given period of time. Also, the total income earned within an economy over a given period of time.
What is real national income?
The total value of the output of goods and services within an economy over a given period of time adjusted to account for changes in the price level.
What is GDP per capita?
The total output of the economy divided by the number of people within the economy.
Why is it useful to have GDP per capita if there is a sudden increase in the birth rate in an economy?
Output may increase as demand for goods and services increases but the new members of the economy are unable to make any contributions so GDP per capita decreases.
What are the four agents in the circular flow model?
Households, businesses/firms, government and the external sector.
What is an injection?
When money enters the circular flow of income from outside.
What is a leakage/withdrawal?
When money leaves the economy.
What happens if there is an increase in injections or leakages into an economy?
This will affect the GDP of the economy. If there is more money entering the economy, then households have more to spend and consumption of goods and services will increase.
What happens if a firm decides to borrow money from a bank and spend that money on new machinery?
This counts as investment and is an injection. The money being borrowed wasn’t previously present in the economy as it was being held by banks now it has entered the circular flow of income, spending on capital goods can increase. The money spent on the capital equipment is revenue received by the firms who produce it, they in turn will pay their labour force who produced it and they can now consume more goods and services, increasing national income.
What is investment?
Money spent by firms on capital goods to aid production. Often funded through borrowing from financial institutions.
What are imports?
The value of goods and services bought from outside an economy.
What are exports?
The value of goods and services produced within a national economy and sold abroad.
What does ceteris paribus mean?
Apart from the stated change, all other variables that may influence an economic outcome remain unchanged.
What is the government?
The body concerned with maintaining a stable social structure so the economy can operate.
What is expenditure?
Spending by households on goods and services.
What is income?
Rent, wages, profit and interest rates paid to those who provide the factors needed for production.
What are savings?
Households putting income aside for future use and to earn interest.
What is the financial sector?
Institutions which take money from households and lend it to firms to invest in capital.
What is taxation?
Levies imposed on profits and incomes earned by households and firms.
What are firms?
Economic agents that turn factors of production into consumable goods and services.
What does national income measure?
Real national income measures GDP (doesn’t include incomes from overseas assets) but GNI does
How successful the economy is, how well off the population is (through measuring national income per person) and allows a government to estimate how much can be collected in tax (most are placed on incomes and expenditure which are both measures of NI)
Why does income=output=expenditure?
It can be calculated through the expenditure method (adding up all the spending over a period of time of the AD formula), the income method and the output method (totalling the value of output of each sector produced for a period of time)
so national income= national expenditure= national output
All 3 methods give the same value as they include the same economic transactions for a period of time but viewed from a different perspective, eg. one’s spending is another’s income
Income=expenditure because everything households spend come from factor incomes from firms and when we spend our money we’re generating income for the supplier
Expenditure=output because all the output of households is spent on goods and services that households produce
How does real national income differ from nominal national income?
Nominal is when the income is unadjusted for changes in price
Real national income removes the effect of price changes from the value of national income
This means that any increase in real income refers to increases in output (or income) instead of higher prices charged for the same amount of production
How is real NI measured?
nominal NI x price level in previous year/ price level in current year
How is economic growth measured?
percentage change in real national income over one year
What is macroeconomic equilibrium?
When the level of national income has no tendency to change
