The Determination of National Income Flashcards
chapter 20
define ‘the circular flow of income’
the flow of receipts and expenditure between companies and households.
Diagramm of the circular flow of income in closed economies.
households - get income for supplying the factors of production to a firm
leakages: tax to the government
savings to the banks
firms - get income from spendings on their outputs by households
injections: government expenditure
investment from banks
Diagramm of the circular flow of income in open economies.
households - get income for supplying the factors of production to a firm
leakages: tax to the government
savings to the banks
imports from foreign markets
firms - get income from spendings on their outputs by households
injections: government expenditure
investment from banks
exports to foreign markets
formula for a firms income (Y)
Y = C + I + G + (X - M)
consumption, investment, government current expenditure, exports, imports
what is the average propensity to consume?
the proportion of total income spent.
formula for the average propensity to consume!
APC = total consumption divided by total income
what is the marginal propensity to consume?
the proportion of each additional unit of income that is spent.
formula for the marginal propensity to consume!
MPC = change in consumption divided by change in income
what does consumption depend on?
- level of income, irrespective of source
- availability of credit
- rate of interest (opportunity cost of spending)
- Rate of income taxation
what does investment depend on?
- cost of capital goods
- businesspeople’s expectations
- government expenditure
- productive capacity of the economy
- state of technology
what do exports depend on?
- levels of income abroad.
- competitiveness
- value of the euro
what do imports depend on?
- availability of goods
- foreign prices vs. domestic prices
- levels of incomes (irrespective of source)
- value of the euro
- marginal propensity to import (MPM)
formula for the marginal propensity to import!
MPM = change in imports divided by change in income
define the marginal propensity to import (MPM) !
the proportion of each additional unit of income that is spend on imports.
what is the multiplier ?
shows the precise relationship between an initial injection into the circular flow of income and the eventual increase in national income resulting from the injection.
what is the multiplier effect?
a change in spending will cause a change in national income, but the change in income is likely to be much greater than the initial expenditure.
formula for the multiplier!
1 divided by 1- MPC
or
1 divided by MPS
…shows the precise relationship between an initial injection into the circular flow of income and the eventual total increase in national income resulting from the injection.
… developed by John Maynard Keynes
what is meant by the ‘marginal propensity to save’ ?
the percentage of savings held out of the last increase in income
i.e. if you don’t spend money (or pay tax) you must save it.
formula for the marginal propensity to save !
MPS = 1 - MPC
Factors that affect the savings rate in the Irish economy .
- Futur expectations for the economy
- security of savings
- price levels / real rate of interest
- quality of financial products
- future levels of state benefits
- deferred spending (i.e 1)
what are economic effects that an Increase in the rate of savings may have on the Irish economy.
- reduced spending
- increased level of funds available for investment
- reduced inflation
- reduced demand for imports
- more capitalized banks
- increased revenue for government
what are transfer payments?
payments received for which no factor of production has been supplied or offered.
income people received for which they did not supply goods or services.
what are the impacts of transfer payments on the multiplier?
the receiving person has a high MPC and spends more.
the use of transfer payments actually speeds up the pace at which money moves in the economy and this has a positive impact.
what are the impacts of shocks on the economy or circular flow of income?
(give case studies as examples)
case study 1 : a sudden rise in the price of oil. -no choice of a substitute -large leakage -lower economic activity
case study 2 : a factory closure -staff loses jobs -incomes fall -government receives less tax -if the factory was exporting their goods, there is an additional loss of an injection
the Keynesian presentation of national income
45 C diagram to illustrate consumption at different levels of income
what is a trade circle ?
refers to recurring patterns of expansion and contraction in the economy.
… provides information on the relationship between prices, employment and investment
i.e. almost all the major industrialized economies of the world have experienced a continuous succession of booms and slumps.
briefly name the 5 phases of the trade cycle!
- recovery
- boom
- recession
- depression
- back to the beginning of the cycle
explain phase 1 of the trade cycle (recovery)
the economy starts from a depressed state (high unemployment, low prices and output)
an increase in investment with the multiplier effect leads to increased incomes and demand.
this increased level of demand leads to a further increase on investment capital, anticipating future profits.
this leads to increased economic activity and recovery.
explain phase 2 of the trade cycle ( boom)
as demand increases , the level of employment increases.
any further increases in demand can not be satisfied by increases in production.
leads to price increases via inflation
explain phase 3 of the trade cycle (recession)
the boom comes to an end
output is at its full capacity and investment begins to decrease.
fall in consumption
profits and prices fall - wave of pessimism
demand for new capital equipment falls
explain phase 4 of the trade cycle (depression)
occurs only in extreme circumstances.
very deep fall-off of economic activity
when a recession has persisted for an extended period of time and the economy has seen a real decline of GDP by more then 10%.
what are the positive consequences of economic growth?
increases employment,
improved government finances,
effect on balance of payment,
improved standard of living,
effects on migration,
investment opportunities
what are the negative consequences of economic growth?
inflationary pressures,
labour shortages,
damand for wages increases,
increased demand for imports,
pressure in the housing market,
increased immigration/displacement of population.
pressure on state infrastructure
what is the accelerator principle?
…states that an increase in demand for final goods results in a more than proportional increase in demand for capital goods.
what do you know about John Maynard Keynes ?
1883-1946
his mayor work: The General Theory of Employment, Interest and Money
output is demand determined
the multiplier
government intervention (laissez-faire thinking)
liquidity preference Theory
(transitionary, precautionary, speculative )
national Y could be in equilibrium at less than full employment
investment decisions by entrepreneurs
