The Circular Flow Of Income Flashcards
Q: What is the multiplier effect?
A: The multiplier effect is the phenomenon where an initial change in aggregate demand leads to a greater final impact on equilibrium national income due to further rounds of spending stimulated by injections of demand into the circular flow of income.
Q: How does the multiplier process work?
A: The multiplier process works through a chain reaction of expenditures. For example, a $300 million increase in investment will increase incomes for firms producing the capital goods. If these firms spend 60% of this income, then $180 million will be added to others’ incomes, continuing the process and increasing total income.
Q: What is the formula for the multiplier in a closed economy with no government?
A: The formula is
Multiplier = 1/MPS or 1/1-MPC
Q: What does MPC stand for and what does it represent?
A: MPC stands for Marginal Propensity to Consume, which is the fraction of additional income that is spent on consumption.
Q: What are some factors that affect the size of the multiplier effect?
A: Factors include the propensity to consume, the propensity to import, and the availability of spare capacity in the economy.
Q: What is the role of government in the Keynesian view of national income determination?
A: The government plays an active role in demand management by influencing the components of aggregate demand through spending and taxation policies to achieve full employment and stable economic growth.
Q: What are the components of Aggregate Demand (AD)?
A: The components are Consumption (C), Investment (I), Government Spending (G), and Net Exports (X-M).
Q: What is the Keynesian Consumption Function?
A: The Keynesian Consumption Function is written as C=a+c(Yd), where C is total consumer spending, a is autonomous spending, and c(Yd) is the propensity to spend out of disposable income.
Q: What is autonomous spending?
A: Autonomous spending is consumption that does not depend on the level of income, funded by savings or borrowing.
Q: How does a change in interest rates affect consumption?
A: A cut in interest rates boosts consumption by lowering the cost of servicing debt, while higher interest rates curb consumer spending.
Q: What is the Marginal Efficiency of Capital (MEC) Theory?
A: The MEC Theory states that it is profitable to invest as long as the MEC (the percentage return) is greater than the rate of interest, with the optimal level of investment being where the MEC equals the rate of interest.
Q: What factors influence investment demand?
A: Factors include business expectations, expected returns, costs of production, and the cost and availability of finance.
Q: What is Gross Domestic Fixed Capital Formation (GDFCF)?
A: GDFCF is expenditure on fixed assets such as buildings and vehicles, either for replacing or adding to the stock of fixed assets.
Q: What are the reasons for government spending?
A: Reasons include providing public and merit goods, redistributing income and wealth, regulating economic activities, influencing resource allocation and industrial efficiency, and influencing the level of macroeconomic activity.
Q: How does the exchange rate affect net exports?
A: An appreciation of the domestic currency encourages imports by making foreign goods cheaper and hurts exports by making domestic goods more expensive abroad, while depreciation has the opposite effects.
