National Income- Theme 2 Flashcards
What is the circular flow of income?
Model to show how money flows around the economy between consumers/households and firms involving withdrawals (taxation, saving and imports) and injections (investment, government spending and exports).
Define wealth effect.
The effect on incomes or spending when asset values change.
What’s the difference between income and wealth.
Wealth is a stock concept, income is a flow concept, means that wealth doesn’t have a direct impact on the circular flow of income but changes in wealth have an effect on incomes and spending.
Explain the impact of injection and withdrawals on the circular flow of income.
If all injections = all withdrawals then the economy will be in equilibrium; if injections are greater than withdrawals, economy will grow; if withdrawals greater than injections, economy will contract.
Explain the concept of equilibrium real national output.
When AD meets AS there is an equilibrium point, which tells us price level and real GDP of a country. An equilibrium is a balancing point where there is no tendency to change price level or output level.
Describe how shifts in AD or AS cause changes in equilibrium price level and real national output.
- if prices were higher than new equilibrium, there’d be tendency for prices to fall as supply would be greater than demand and there’d be lots of unsold goods and services.
- if prices lower than new equilibrium, there’d be shortages and prices start to rise in order to make sure everyone could get what they were prepared to pay for.
Define the multiplier ratio.
The ratio of a change in equilibrium real income to the autonomous change that brought it about.
Define marginal propensity to consume (MPC).
A measure of how much of any extra pound earned is spent within the economy.
How do you calculate the multiplier?
1/(1-MPC) or 1/MPW , where MPW=MPS+MPT+MPM
What is the significance of the multiplier for shifts in AD.
Larger value of multiplier, the greater the shift in AD. Larger withdrawal, smaller multiplier.
What is the effect of the multiplier on the economy.
If any change in spending in an economy, final impact on incomes will be much greater than the initial incomes. Formula based on how much of any extra pound earned is re-spent within economy.
Define marginal propensity to withdrawal (MPW).
A measure of how much of any extra pound earned is saved, taxed or spent outside the economy on imports. It’s he sum of marginal propensity to save(MPS), marginal propensity to tax(MPT), and marginal propensity to import(MPM).
What factors can cause the multiplier to increase.
- fall in withdrawals from circular flow of income will lead to a rise in the value of the multiplier
- increase in MPC will cause the value of the multiplier to rise
Define national income.
total spending on goods and services
