Theme 2 - National Income Flashcards
income
Income is a flow of money that goes to the factors of production. For example, wages, welfare payments, profits, dividends, rents and interest are forms of income.
wealth
Wealth is a stock of assets, such as savings, shares, property, bonds and pension schemes. sum of all assets in the economy
circular flow of income
Firms and households interact and exchange resources in an economy. Households supply firms with the factors of production, such as labour and capital, and in return, the firms pay for the factors of production in the form of rent, wages, profit and interest.
Firms supply goods and services to households. Consumers pay firms for these. This spending and income circulates around the economy in the circular flow of income.
wealth effect
the effect on incomes or spending when asset values change.
injections
Flows into the circular flow of income comprising investment, government spending and exports.
withdrawals
Flows out of the circular flow of income comprising savings, tax and import
equilibrium
The economy reaches a state of equilibrium when the rate of withdrawals = the rate of injections. This is equivalent to the point where AD = AS.
The multiplier ratio
This is the ratio of the rise national income to the initial rise in AD. In other words, it is the number of times a rise in national income is larger than the rise in the initial injection of AD, which led to the rise in national income.
The multiplier process
The multiplier effect occurs when there is new demand in an economy. This leads to an injection of more income into the circular flow of income, which leads to economic growth. This leads to more jobs being created, higher average incomes, more spending, and eventually, more income is created.
The multiplier effect refers to how an initial increase in AD leads to an even bigger increase in national income.
Effects of Marginal propensity to consume (MPC) on the multiplier
A consumer’s marginal propensity to save is the proportion of each additional pound of household income that is used for saving.
The higher the MPC, the bigger the size of the multiplier.
The government could influence the MPC by changing the rate of direct tax. If consumers have more disposable income due to lower income tax rates, their propensity to consume might increase.
Effects of Marginal propensity to save (MPS) on the multiplier
A consumer’s marginal propensity to save plus the marginal propensity to consume is equal to 1.
If consumers save more than they spend, the size of the multiplier will be small.
Effects of Marginal propensity to tax (MPT) on the multiplier
This is defined as the proportion of each pound taxed by the government. The higher the rate of tax, the less disposable income each consumer has, and the smaller the size of the multiplier.
Effects of Marginal propensity to import (MPM) on the multiplier
If consumers spend income on imports rather than domestic goods and services, income is withdrawn from the circular flow of income. This reduces the size of the multiplier.
Calculating the multiplier
o One formula that can be used to calculate the multiplier is 1/(1-MPC).
o Example:
If consumers spend 0.6 of every £1 they earn, they save 0/4. Therefore, the multiplier will be:
1/(1-0.6) = 1/0.4 = 2.5.
This means that every £1 of income generates £2.50 of new income.
o another formula for calculating the multiplier:
o 1/MPW
o An open economy has three areas of withdrawals: taxes, imports and savings. o The marginal propensity to withdraw is calculated by MPW = MPS + MPT +
MPM
Marginal propensity to withdraw
A measure of how much of any extra pound earned is saved, taxed or spent outside the economy on imports
