T2: LS5 & LS7 - Circular Flow & Multiplier Flashcards
Circular flow of income definition
Circular flow of Income: an economic model showing how money and G&S move through an economy. Includes economic agents showing the transfer or money and changes to the money supply of an economy
Who are the main economic agents in the circular flow of income?
- Consumers/Households
- Government
- Producers/Firms
- Foreign sector
- Banks
What are the three main withdrawals/ leakages in the circular flow?
S - Savings: removes money from the economy as consumers save it instead of spending.
T - Taxes: removes money as it is paid to the government so is not spent on consumption.
M - Imports - Removes money from the economy as it is paid to foreign economies.
What are the three main Injections in the circular flow?
I - Investment: increases cash flow to firms helping them spend in the economy.
G - Government spending: can be supplied to both consumers or producers helping expenditure.
X - Exports: increases money supply as foreign economic agents pay firms for G&S provision.
Wealth and Income definition
Income: refers to the flow of money received by an individual, household or firms in return for proving factor incomes or G&S.
Wealth: the stock of assets owned by a person in monetary value including property, stocks and savings.
Injections definition
Injections: refers to the addition of income and money into the flow of G&S in an economy.
Withdrawals/ leakages definition
Withdrawals: refers to the leakages or loss of income and money out of the flow of an economy.
What do firms provide households and what do households provide firms in the circular flow of income?
Households: provide firms with factors of production helping them produce G&S
Firms: provide households with factor incomes allowing them to consume.
What is the concept of Equilibrium Real National Output
Equilibrium real national output: when AS equals AS meaning total output is matched by the total demand for output.
What is the multiplier effect (definition)?
Multiplier: occurs when an initial injection into the circular flow causes a larger final increase by a co-efficient value multiplier in *real national income**.
How does the multiplier effect work?
- Initial increase in income from injections or spending occurs
- Leads to further profit and production
- Leads to further spending
- Increases overall impact on national income
How does the multiplier impact demand-side policy
Multiplier amplifies the impacts of:
- Expansionary Fiscal policy from government expenditure
- Expansionary Monetary policy from encouraging investment and more export competitiveness
What does marginal propensity mean and how does it impact the multiplier?
- Marginal propensity: refers to the proportion of income which consumers/ households are willing to spend on different leakages.
- withdrawals can impact the level of national income and reduce the multipliers’ effects
What is MPC?
Marginal propensity to consume (MPC): the additional income spent on consumption of G&S. Larger MPC’s lead to larger multipliers
What is MPS?
Marginal propensity to save: refers to the proportion of income which consumers are willing to save rather than spend. Results in larger withdrawals and smaller multiplier impacts
What is MPT
Marginal propensity to Tax (MPT): The proportion of additional income which consumers/ households pay as taxes. Leads to larger withdrawals and a smaller multiplier.
What is MPM?
Marginal propensity to import (MPM): The proportion of additional ci nome which consumers are willing and do spend on imports. Increases withdrawals and reduces multiplier
What is the accelerator effect?
Accelerator effect: Refers to the increase in investment which occurs as higher demand leads to higher National income leading to higher investment which then cycles around as higher demand.
Equation for the multiplier
Change in Real GDP (Y)/ Change in injections
Closed economy and no government: 1/1-MPC or 1/MPS
Open economy and government: 1/MPS + MPM + MPT
