The Operation of an Economy - Topic 1

Question 1

What are the different parts of the circular flow of income?

Answer 1

Consumers (household) (Income, consumption from firms sector)
Businesses (Firms) (Goods and services, Economic Resources from household sector)
Financial Sector (Saving, Investment)
Government (Tax, Expenditure)
Overseas sector (imports, exports)

Question 2

What is a leakage?

Answer 2

When money is brought out of the circulation through savings, taxation and imports. Basically this money isn’t being used and is brought out of the economy

Question 3

What is an Injection?

Answer 3

An injection is when money is brought into back into the circular flow between the household and firms sector. Basically this money is being brought back into the economy. This is done through Financial sector investment, gov. expenditure and exports

Question 4

What are the different parts of the business cycle and what do they mean?

Answer 4

Peak (top)
Trough (bottom)
Expansion (the process of an economy having an increased output over time)
Contraction (the process of an economy having a decreased output over time)
Depression ( an extended period of an economy having a decreased output)

Question 5

What is the business cycle?

Answer 5

The business cycle refers to fluctuations in the growth in economic output over time

Question 6

What is considered as output in the business cycle?

Answer 6

Output is defined as real gross domestic product (GDP adjusted for inflation)

Question 7

What happens during an expansion of a business cycle?

Answer 7

Households demand more goods and services
Business hire more workers
Wages and prices rise

Question 8

What happens during a contraction of the business cycle?

Answer 8

Households have fewer demand for goods and services
Businesses reduce the number of workers
Growth in wages and prices slows

Question 9

What is a recession?

Answer 9

A recession is defined as a sustained period of time (6 months) of weak or negative growth in real GDP with a significant rise in unemployment rates?

Question 10

What are common features of a recession?

Answer 10

Lower economic output

Undesirable labour outcomes

Question 11

What is the difference between recessions and depressions?

Answer 11

A depression is a prolonged and bigger version of a recession

Question 12

What is the effect of the economy expanding (generally)? (5)

Answer 12

Production increases (businesses)
Unemployment decreases
Wages increase
Consumer spending increases 
Price increase

Question 13

What is the effect of the economy contracting (generally)? (5)

Answer 13

Production decreases (businesses)
Unemployment increases
Wages decrease
Consumer spending decreases
Prices decrease

Question 14

What does the RBA do in response to the economy expanding?

Answer 14

The reserve Bank increases interest rates to encourage people to spend less (prevent really high inflation)

Question 15

What does the RBA do in response to the economy contracting?

Answer 15

The Reserve Bank decreases interest rates to encourage people to spend more

Question 16

What is the impact of an expansion on the government?

Answer 16

Increased collection of company and personal taxes

Reduced spending on social welfare payments

Question 17

What is the impact of a contraction on the government?

Answer 17

Decreased collection of company and personal taxes

Increased spending on social welfare payments

Question 18

What is the impact of an expansion on the individuals? (4)

Answer 18

Increased wage growth
Lower unemployment
Higher inflation
Increased quality of life

Question 19

What is the impact of a contraction on the individuals? (4)

Answer 19

Lower wage growth
Increased unemployment
Lower inflation
Decreased quality of life

Question 20

What is the impact of an expansion on businesses? (3)

Answer 20

Increased production
Increased investment in new equipment/ expansion
Increased profits

Question 21

What is the impact of a contraction on businesses? (3)

Answer 21

Decreased production
Decreased investment in new equipment/ expansion
Decreased profits

Question 22

What are some of the long term effects of recessions?

Answer 22

Result in an increase in unemployment and business failures
Unemployment takes a long time to decline after a recession
Business failures permanently put the business out of business even though they may have something revolutionary
Increased nation’s public debt

Question 23

What is the circular flow of income?

Answer 23

It is a theoretical model that shows how income and goods and services flow throughout the economy. It has 5 sectors to it

Question 24

What are the different simplified versions of the circular flow of income? (not rlly necessary)

Answer 24

2 sector model - Household and firms
3 sector model - Household, firms, financial
4 sector model - Household, firms, financial, government

Question 25

Explain the interdependence of the 5 different sectors of the circular flow of income?

Answer 25

The interdependence basically means that the 5 sectors all depend on each other. This can be seen in an example of the interdependence between households, firms and financial sectors:

When the household provides labour for the firms sector in return for wages, they can use their money to purchase goods or services from the firm which will make sure the firm can stay in business.. Once the household has spent what they need, they can place their savings into financial sectors. These financial sectors will reinvest the money into firms. This in turn keeps business alive so they can pay their workers and the cycle continues

Question 26

How do you calculate if the economy is stable (in equilibrium) (related to circular flow of income)?

Answer 26

It is achieved when injections = leakages (investment + government expenditure + Exports = Savings + taxation + Imports)

Question 27

What happens when I+G+X > S+T+M

Answer 27

The economy will expand

Interest + government expenditure + exports > Savings + taxation + imports

Question 28

What happens when I+G+X < S+T+M

Answer 28

The economy will contract

Interest + government expenditure + exports < savings + taxation + imports