Theme 2 Topic 4

Question 1

What is the circular flow of income ?

Answer 1

An economic model showing the flow of goods and services, the factors of production, and their payments between households and firms within an economy.

Question 2

What does the simple model show ?

Answer 2

UK economy is complex + operates in a global environment.
this means the model is simplified.
we assume the economy is ‘closed’.
there is no foreign trade nor government influence.
the 2 groups are forms and households.

Question 3

What does the circular flow of income show ?

Answer 3

Simple model to show flow of money around an economy
Only two entities Households and firms
Money moves around the economy from households (owners of the factors of production) when they purchase goods and or services to Firms and then back again in the form of wages, rent, interest and profit

Question 4

what does national output equal ?

Answer 4

national expenditure = national income

Question 5

what are the 4 stages of the circular flow of income ?

Answer 5

1)Firms provide households with goods and services
2) Households spend their income on the goods and services produced by firms
3) Households also provide firms with factors of production:
Land, Labour, Capital & Entrepreneurship
4) In order to pay for these factor services, firms pay households rent, wages, interest and profit

Question 6

How does GDP influence the flow of income ?

Answer 6

The more households spend the more firms produce. Demand drives supply.
Income and output should always have the same value in a closed model
We measure income/output using GDP

Question 7

land labour capital :

Answer 7

buildings, output, investment

Question 8

rent, wages, interest, profit

Answer 8

land, labour, capital, entrepreneurship

Question 9

what are the 4 assumptions that cause the model to be unrealistic ?

Answer 9

1. Households spend all their income on goods
   and services
2. Firms spend all their income on factors of
   production
3. There is no government
4. There is no foreign trade

Question 10

what is the correlation between income and wealth ?

Answer 10

wealth is a stock concept.

income is a flow concept.

as income flows from the stock of assets a nation’s income and wealth are directly correlated

Question 11

how is wealth a stock concept ?

Answer 11

assets owned (e.g. buildings, land)

human wealth (e.g. skills, education)

Question 12

how is income a flow concept ?

Answer 12

money generated from wealth (e.g. wages, rent, interest)

Question 13

income + wealth correlation :

Answer 13

 An increase in income will have a direct impact on wealth, providing the finance for investment
 Investing in the productive capacity of the economy will increase the stock of physical assets, therefore increasing wealth
 This will lead to economic growth and higher income in the future
 In turn, this will allow us to further increase our stock of wealth
 There is an opportunity cost between consumption today and consumption in the future
 By investing in our stock of wealth by increasing productive capacity we can increase our future income

Question 14

what are the 3 injections ?

Answer 14

1. Investment (increase in capital stock)
2. Government spending
3. Export purchases

Question 15

what are the 3 leakages ?

Answer 15

1. Savings
2. Taxation
3. Import purchases

Question 16

how is the flow of income link shown on the PPF curve ?

Answer 16

-There is a trade-off between using our income for consumption today and consumption for future generations
- If we use our income to invest in capital goods today it means that we are increasing our productive capacity
• This means that we have a greater stock of wealth
• An increase in capital goods will shift the PPF outwards
• This economic growth will lead to higher income in the future

Question 17

Why do we consider injections and withdrawals ?

Answer 17

To take into account a more realistic role of all the participants in the circular flow.

Question 18

How are injections + withdrawals shown on the circular flow of income diagram.

Answer 18

Injections go in

Withdrawals go out

Question 19

What are injections ?

Answer 19

Monetary additions to the economy.

Question 20

What are leakages ?

Answer 20

Money is removed from the economy

Question 21

injection greater than leakage :

Answer 21

economy grows

Question 22

injection less than leakage :

Answer 22

economy shrinks

Question 23

injection in equilibrium with leakage :

Answer 23

national income remains the same