National Income Flashcards
Tell me about the simple model of the circular flow of income
Imagine the economy as a simple model where there are just households and firms. The households own all the factors of production- land, labour, capital and enterprise- and the firms are the producing units. Money moves from households to firms when they buy goods and services; and money moves back to households as payment for the use of factors of production in the form of rent, wages, interest and profit. In this simple model, known as the circular flow of income, money circulates from households to firms and back again, and the more that households spend and the more that firms produce, the higher the levels of income. It does not matter which way you look at it, the income and output in an economy should always be the same, and they are measured by gross domestic product.
In the circular flow of income, what two things should be the same
The income and output in an economy should always be the same. They are measured by gross domestic product.
Make sure to look at a diagram of the circular flow of income on page 33 of theme 2 book
O to the K
What is wealth
Wealth is the sum of all assets in an economy. It is, therefore, a stock concept.
What is income
Refers to the amount of income earned during a period of time. Therefore, in contrast to wealth, it is a flow concept.
Define wealth
A stock concept which refers to the total value of assets in an economy at a given moment in time.
Define income
A flow concept which refers to the value of income earned over a period of time.
Explain to me what the wealth effect is
In the UK, most wealth is held in the form of housing (almost 60%); the other major forms of wealth are stocks and shares and capital assets. This means that wealth does not have a direct impact on the circular flow of income, but changes in wealth have an effect on incomes and spending (the wealth effect)
For example, if you live in a property that increases in value, you might feel more confident about spending in the economy and your increased spending will then become part of the circular flow of income. Moreover, if houses become more expensive, people may go to their mortgage providers and request mortgage equity release, i.e. take out a loan based on the increased value of their homes. When the loan is spent, the circular flow increases. By contrast, if capital markets take a downturn in the USA, people living on pensions in the uk might find that their incomes fall because dividends on pension funds are often based on capital gains of shares.
Where is wealth held in the UK
In the UK, most wealth is held in the form of housing (almost 60%); the other major forms of wealth are stocks and shares and capital assets.
Define the wealth effect
The effect on incomes or spending when asset values change.
What are the 3 injections into the circular flow of income:
investment (an increase in capital stock), government spending and exports. These all increase the circular flow and a change in any will be magnified by the multiplier.
I + G + X
What are the three withdrawals (leakages) from the circular flow of income:
Savings, tax and imports.
If people decide to save more of their incomes, the economy slows down because their is less money in the circular flow. Similarly, if the government increases taxes and does not spend the money, or if people spend more on imports, the economy will slow down as money leaves the circular flow. These three leakages effectively determine the size of the multiplier.
Define injections
Flows into the circular flow of income comprising investment (I), government spending (G) and exports (X)
Define withdrawals
Flows out of the circular flow of income comprising savings (S), tax (T) and imports (M)
If all injections equal all the leakages what happens?
The economy will be in equilibrium.
If injections are greater than leakages, the economy will…
Grow
If leakages are greater than injections the economy will…
Contract
What does the circular flow of income diagram look like
Households at the top and firms below, areas going to households and from firms both ways. An arrow from households to firms is factors of production. An arrow from firms to households is goods and services.
Arrows pointing to the circle as I, G and M (factor incomes) and arrows pointing outwards as S, T and M (spending on goods and services)
When AD meets AS there is an…
Equilibrium point, which determines the price level and real GDP of a country. An equilibrium is a balancing point where there is no tendency for price level or real output to change.
What happens to the equilibrium when there is a shift in AD or AS
There is a movement away from the original equilibrium to form a new equilibrium.
How does a new equilibrium form if price level was higher than the new equilibrium (or point at which the new AD and AS cross)
There would be a tendency for the price level to fall because aggregate supply would be greater than aggregate demand and there would be a surplus of goods and services.
If the price level was lower than the new equilibrium what would happen..
There would be shortages of goods and services and the price level would start to rise in order to make sure that everyone could get what they were prepared to pay for.
If there was a worldwide recession and a fall in AD occurred, the the price level would be likely to…
Fall.
What’s the multiplier ratio
The multiplier ratio is the ratio of a change in equilibrium real income (GDP) to the autonomous change (the injection) that brought it about.
In other words, it is the number of times a change in GDP exceeds the change in net injections and withdrawals change.
For example, if there is a £10 billion increase in export values, the inward flow of money to the UK will be re-spent within the UK. When the money is spent, it becomes other people’s incomes. These incomes will be re-spent and so on. Consequently, if the final increase in GDP is £20 billion then the value of the multiplier would be 2.
What’s the most important factor in determining the size of the multiplier
The size of the withdrawals from the circular flow, I.e what proportion of the additional income is saved by households, what proportion is spent on imported goods and what proportion is paid to the government in the form of taxation.
The multiplier has what symbol
K
What is the multiplier inversely proportional to
The marginal propensity to withdraw (MPW)
K = 1/MPW
What is the MPW
Marginal propensity to withdraw (MPW) is the proportion of one unit of additional national income which is withdrawn from the circular flow, or the sum of the MPS, MPT and MPM
What is the MPW equal to
The marginal propensity to save (MPT) + marginal propensity to tax (MPT) + the marginal propensity to import (MPM)
MPS + MPT + MPM
Therefore, the formula for the multiplier can also be written as
K= 1/MPS+MPT+MPM
Define the marginal propensity to withdraw
(MPW) it’s a measure of how much of any extra pound earned is saved, taxed or spent on imports.
Tell me a formula for the multiplier involving the MPC
The MPC = marginal propensity to consume. If you add together the MPC and MPW you get 1, I.e the total amount. Therefore if MPC + MPW = 1, a rearrangement of the formula gives the value of MPW as (1-MPC)
So,
K = 1/1-MPC
Define marginal propensity to consume (MPC)
A measure of how much of any extra pound earned is spent within the economy.
Tell me the 3 formulas for calculating the multiplier
K = 1/MPW
K= 1/MPS + MPT + MPM
K= 1/1-MPC
Tell me what the importance of the multiplier is
If there is any change in spending in an economy, the final impact on incomes (GDP) will be greater than the initial injection. The greater the leakages, the smaller the multiplier. The formula is based on how much of any extra pound earned is re spent within the economy, I.e the marginal propensity to consume (MPC).
What’s the size of the multiplier in the uk
It’s approximately 1.4 in the UK, but in developing countries it is often higher, which partly explains their higher growth rates.
If the multiplier is larger, what happens to AD
The larger the value of the multiplier, the greater the shift in AD. For example if the multiplier is 1.1 in Japan a 100 trillion Yen injection into the economy by the Japanese government will have a 110 trillion positive impact on AD. If the multiplier was 2.0 the effect is 200 trillion yen.
This can both be positive and a negative direction. So an increase in leakages, for example because imports rise, will have a larger negative impact on AD depending on the size of the multiplier.
Income is a ____ concept?
Flow concept.
Income (eg. Export income) is a flow concept
Wealth is a ____ concept
Wealth (eg capital assets) is a stock concept
What was the value of wealth in the UK economy in 2018
Over £10 trillion, five times the GDP of the economy.
In 2018, how was the UKs wealth held
Just over half of the UKs wealth was held in the form of land. The rest in pension funds, life insurance funds, capital assets and shares.
Changes in injections have what effect on the total level of spending in the economy
A multiplier effect. An increase in injections has a proportionately larger effect on GDP.
Changes in leakages affect the size of the….
Multiplier. The larger the leakages, the smaller the value of the multiplier.
Is consumption an injection into the circular flow
No, the injections are investment, government spending and exports.
