Macro 2.4 Flashcards
What is the circular flow of income model?
A model showing the flow of money and goods between households and firms in a two-sector economy
It illustrates how households provide factors of production to firms in exchange for income, which they then use to purchase goods and services.
What are the three ways to measure economic activity in the circular flow model?
- National output
- National expenditure
- National income
In the two-sector model, how do national output, national expenditure, and national income relate?
They are equal: national output = national expenditure = national income.
What role does the government play in the circular flow of income?
The government takes money out through taxation (T) and adds money through spending (G).
What are injections in the economy?
- Government spending (G)
- Investment (I)
- Exports (X)
What are withdrawals (leakages) in the economy?
- Taxes (T)
- Savings (S)
- Imports (M)
What happens if injections are greater than withdrawals?
The economy will be growing.
What is the equilibrium condition in the circular flow model?
Injections must equal withdrawals.
What determines the equilibrium level of national output?
The intersection of Aggregate Demand (AD) and Aggregate Supply (AS) curves.
In the short run, how do Keynesian and Classical economists view the AD and AS curves?
AD is downward sloping and AS is upward sloping.
What occurs when the AD curve shifts to the right?
Prices and real GDP increase.
In the long run, how do Classical economists view the LRAS curve?
It is perfectly inelastic; changes in price do not affect output.
What is the belief of Classical economists regarding full employment?
The economy will always return to full employment in the long run.
What is a positive output gap according to Classical economists?
When the economy operates above full employment, leading to increased costs and prices.
What do Keynesians believe about equilibrium in relation to employment?
Equilibrium can occur at less than full employment.
What is the effect of a shift from AD3 to AD4 according to Keynesians?
It is purely inflationary, affecting only prices, not output.
What do Keynesians argue during deep recessions?
The government needs to work to increase aggregate demand (AD).
Fill in the blank: Injections are monetary additions to the economy, including government spending (G), investment (I), and _______.
exports (X)
Fill in the blank: Withdrawals or leakages are where money is removed from the economy, such as taxes (T), savings (S), and _______.
imports (M)
What is the relationship between investment and aggregate demand (AD) in macroeconomics?
An increase in investment will increase AD and potentially increase long-run aggregate supply (LRAS).
What is the impact of a rise in long-run aggregate supply (LRAS) on prices and output?
It is likely to lead to lower prices and higher output.
What is the multiplier process?
The idea that an increase in AD due to an increased injection can lead to a further increase in national income
The multiplier is the ratio of the final change in income to the initial change in injection.
How is the multiplier calculated?
Multiplier = 1 / (1 - MPC)
MPC stands for marginal propensity to consume.
What does a higher MPC indicate about the multiplier?
The bigger the multiplier
A higher MPC means more of the income is spent, leading to greater circular flow.
What is the marginal propensity to consume (MPC)?
The increase in consumption following an increase in income
MPC is a key factor in determining the size of the multiplier.
What is the marginal propensity to save (MPS)?
The increase in savings following an increase in income
What is the marginal propensity to tax (MPT)?
The increase in taxation following an increase in income
What is the marginal propensity to import (MPM)?
The increase in imports following an increase in income
What is the marginal propensity to withdraw (MPW)?
The increase in leakages following an increase in income
MPW = MPS + MPT + MPM.
What is the relationship between the multiplier and leakages?
The lower the leakages, the bigger the multiplier
What occurs if there is a negative multiplier effect?
A withdrawal from the economy could lead to a further fall in income
This can decrease economic growth and possibly lead to a decline in the economy.
What factors affect the marginal propensity to consume (MPC)?
Interest rates and other factors that influence consumption
Changes in income or economic conditions can also affect MPC.
What is the effect of the multiplier on economic growth?
Growth can occur quicker as injections lead to a bigger increase in national income
How does the elasticity of the AS curve affect the multiplier’s impact?
The more elastic the curve, the smaller the effect on price but the bigger the effect on output
Fill in the blank: The multiplier tends to be around ______ in developed countries.
1.5
Fill in the blank: The multiplier tends to be around ______ for developing countries.
1.6
What happens to the economy if government plans to cut deficits?
It can lead to an even further decrease of the economy
What is the formula for calculating the increase in national income based on the multiplier?
Increase in national income = Initial increase x Multiplier
True or False: The multiplier has little effect on output when there is little spare capacity in the economy.
True
What must be present in the economy for the multiplier to have the desired effect?
Sufficient spare capacity
What is the outcome if the AS is perfectly inelastic?
The only impact will be to increase price; it will not affect output in the long run
