The Operation of an Economy - Topic 1 Flashcards
What are the different parts of the circular flow of income?
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)
What is a leakage?
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
What is an Injection?
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
What are the different parts of the business cycle and what do they mean?
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)
What is the business cycle?
The business cycle refers to fluctuations in the growth in economic output over time
What is considered as output in the business cycle?
Output is defined as real gross domestic product (GDP adjusted for inflation)
What happens during an expansion of a business cycle?
Households demand more goods and services
Business hire more workers
Wages and prices rise
What happens during a contraction of the business cycle?
Households have fewer demand for goods and services
Businesses reduce the number of workers
Growth in wages and prices slows
What is a recession?
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?
What are common features of a recession?
Lower economic output
Undesirable labour outcomes
What is the difference between recessions and depressions?
A depression is a prolonged and bigger version of a recession
What is the effect of the economy expanding (generally)? (5)
Production increases (businesses) Unemployment decreases Wages increase Consumer spending increases Price increase
What is the effect of the economy contracting (generally)? (5)
Production decreases (businesses) Unemployment increases Wages decrease Consumer spending decreases Prices decrease
What does the RBA do in response to the economy expanding?
The reserve Bank increases interest rates to encourage people to spend less (prevent really high inflation)
What does the RBA do in response to the economy contracting?
The Reserve Bank decreases interest rates to encourage people to spend more
What is the impact of an expansion on the government?
Increased collection of company and personal taxes
Reduced spending on social welfare payments
What is the impact of a contraction on the government?
Decreased collection of company and personal taxes
Increased spending on social welfare payments
What is the impact of an expansion on the individuals? (4)
Increased wage growth
Lower unemployment
Higher inflation
Increased quality of life
What is the impact of a contraction on the individuals? (4)
Lower wage growth
Increased unemployment
Lower inflation
Decreased quality of life
What is the impact of an expansion on businesses? (3)
Increased production
Increased investment in new equipment/ expansion
Increased profits
What is the impact of a contraction on businesses? (3)
Decreased production
Decreased investment in new equipment/ expansion
Decreased profits
What are some of the long term effects of recessions?
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
What is the circular flow of income?
It is a theoretical model that shows how income and goods and services flow throughout the economy. It has 5 sectors to it
What are the different simplified versions of the circular flow of income? (not rlly necessary)
2 sector model - Household and firms
3 sector model - Household, firms, financial
4 sector model - Household, firms, financial, government
Explain the interdependence of the 5 different sectors of the circular flow of income?
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
How do you calculate if the economy is stable (in equilibrium) (related to circular flow of income)?
It is achieved when injections = leakages (investment + government expenditure + Exports = Savings + taxation + Imports)
What happens when I+G+X > S+T+M
The economy will expand
Interest + government expenditure + exports > Savings + taxation + imports
What happens when I+G+X < S+T+M
The economy will contract
Interest + government expenditure + exports < savings + taxation + imports
