Macro Topic 2- Circular flow of income & AD Flashcards
Explain how households and firms interact within the circular flow of income
- Households= provide factors of production to firms
Firms= Use these factors of production to produce goods & services
Explain the 2nd stage of the circular flow of income-
i.e after firms have produced goods & services from the factors of production provided by households.
Households= receive factor incomes (e.g for labour= wages) as a reward for providing the FOP
- Households then use these factor incomes as consumer expenditure on goods & services produced via firms.
Overall what does the circular flow of income model show?
The movement of spending and income throughout the economy.
What is the misconception with regards to FACTOR INCOMES which we assume by the circular flow of income?
We assume that ALL factor incomes are going to be spent on g&s….
Not all income is spent in economy
- incomes= saved, taxed, import spending.
What are the 3 leakages out of an economy?
1) savings- (s)
2) Taxation (T)
3) Imports (M)
What is the misconception with regards to consumer expenditure which we assume by the circular flow of income?
That only CONSUMERS have expenditure on goods & services.
Could be other sources of expenditure in the economy
- Firms= Investment
- Govt= Government spending
- Exports= foreigners spend
What are the 3 Injections into an economy?
Investment (I)= by firms
Government spending (G)
Exports (X)
If injections are GREATER than leakages in an economy. (more money is entering the economy than leaving it)
What is the impact on economic growth?
Economic growth is going to be RISING
If injections are LESS than leakages in an economy(more money leaving our economy than entering it)
What is the impact on economic growth?
Economic growth is going to be DECREASING
If both the injections and leakages in an economy are EQUAL.
What is the impact on economic growth?
There will be no increase or decrease in economic growth
Macroeconomic equilibrium.
What does national income measure?
It is a sum of all the goods and services than an economy produces in a given year.
Total amount of income flowing AROUND an economy.
What is Nominal income?
This is the sum of all goods & services produced in that year at that year’s price.
Generally higher than in reality, because price levels may increase.
What is real income?
This is the sum of all goods & services produced however it takes into account rises in price levels.
What is real national income a measure of?
An economy’s performance over time, therefore it is an indicator of economic performance.
List the 3 methods of calculating GDP.
Output method
Income method
Expenditure method
What is the output method of calculating GDP?
Adding up the final sum of all G&S in an economy.
This is the output method of calculating GDP
What is the income method of calculating GDP?
By adding up all factor incomes earned in an economy earned in a year.
Adding up all the
- wages & salaries
- profits
- Interests
- rent
What is the expenditure method of calculating GDP?
Adding up consumer expenditure=
- investment
- government spending
- net exports
what is the relationship between the output, income and expenditure method?
They all EQUAL each other and so it doesn’t matter which method is used.
output=income=expenditure
Define Aggregate demand
This is the total demand in the economy and it measures total EXPENDITURE
List the components of AD
Consumption
Investment
Government spending
Exports- imports= NET exports
Why is the AD curve downward sloping?
This is because of reasons to do with the price level changing
Explain what the wealth effect is and how it is related to the AD curve being downward sloping
- As price level decreases
- purchasing power of income increases
- so people= more richer
- more spending money on g&s
- consumption INCREASES, causing AD to increase, causing real GDP to increase(shifts right ).
- So extension in AD curve
Explain what the trade effect is and how it is related to the AD curve being downward sloping
- As price level decreases
- Exports= more competitive, imports= less competitive
- demand for exports= increases, and imports demand decreases
- because demand for imports is decreased, M decreases
so the value of (X-M) INCREASES, causing AD to increase, causing real GDP to increase (shifts right ). - So extension in AD curve
Explain what the interest effect is and how it is related to the AD curve being downward sloping
- As price level decreases
- Interest rates can be kept lower in economy
- means that consumption & investment increases & value of (x-m) increases, causing AD to increase, causing real GDP to increase (shifts right ).
- So extension in AD curve
Why would the AD curve shift left or right?
Either an increase or decrease in consumption investment government spending net exports
What is the distinct difference between the reasons for AD curve shifting and extending/ contracting?
AD curve will SHIFT not because of price level but because of its components increasing or decreasing.
AD curve slopes downwards because of the price level.
