Topic 2: Definitions

Question 1

Describe the circular flow of Income

Answer 1

It is the relationship between households and firms. Households give firms consumer spending and factors of production wheras firms give households wages/income/rent and goods/services

Question 2

Injections

Answer 2

This is money that enters the economy.
1. Investment - spending on capital goods will increase output.
2. Exports - more money coming into the economy
3. Govt speding - policies such as increasing welfare would create an incentive to buy more.

Question 3

Withdrawals

Answer 3

This is money that exits the economy.
1. Savings - more savings means less spending
2. Imports - more money leaving the economy therefore less money within the economy
3. Taxes - reduces disposable income.

Question 4

Macroeconomic Equilibrium

Answer 4

When AD = AS
When rate of injections = rate of withdrawals.

Question 5

National income

Answer 5

National income is the total value of goods and services a country produces. It can be measured by GDP (within the economy), GNP (can be earned anywhere) and GNI (total income earned anywhere).

Question 6

Net injections

Answer 6

Expansion of national output

Question 7

Net withdrawals

Answer 7

Contraction of national output

Question 8

Aggregate demand

Answer 8

The total demand for all goods and services in an economy at any given price level over a period of time

Question 9

Aggregate Demand Components

Answer 9

AD = C + I + G + (X - M)
C - Consumption
I - Investment
G - Govt Spending
X - Exports
M - Imports

Question 10

Real national output

Answer 10

The same as GDP (the total value of all goods/services produced within an economy/that a country produces).

Question 11

Consumption

Answer 11

Describes how much consumers spend on goods/services. 60% of AD
Factor 1: Interest rates. High Interest Rates decrease consumption as discourages spending/encourages spending.
Factor 2: Consumer Confidence: if high, then high consumption.
Factor 3. Income. If income high then high consumption.

Question 12

Investment

Answer 12

spending on captial goods (physical assets used in the production process).
Factor 1: Rate of economic growth. If expected to be high, then firms are more willing to invest as they would see higher returns.
Factor 2: Interest rates. If high then greater opportunity to save it.

Question 13

Government Spending

Answer 13

How much the govt spends on state/public goods/services.
Factor 1: the trade cycle
Factor 2: Fiscal Policy

Question 14

(Net) balance of payments

Answer 14

The UK has a relatively large TRADE DEFICIT (X-M) and reduces AD
Factor 1: Income -> imports
Factor 2: Exchange Rate -> ^strength in pound -> cheap materials elsewhere

Question 15

Multiplier effect

Answer 15

The multiplier effect occurs when an initial injection (e.g more exports) into the economy leads to a proportionally larger final increase in GDP.

Question 16

Accelerator effect

Answer 16

It states that a rise in GDP will lead to a proportionally larger rise in investment (in order to meet anticipated demand).

Question 17

Aggregate Supply

Answer 17

Aggregate supply respresents the total quantity of goods/services producers are willing and able to supply at any given price over a given period of time.

Question 18

SRAS

Answer 18

Short-run aggregate supply is aggregate supply assuming a minimum of one factor or production is fixed.

Question 19

SRAS Determinants

Answer 19

They are determined by the costs of production:
1. Wages
2. Raw materials
3. Oil prices (major)
4. Business taxes
5. Exchange rate

Question 20

LRAS (and differences between types)

Answer 20

Long run Aggregate Supply assumes that in the long-run, all factors of production can change.

In the classical model of LRAS, the economy is producing at one level of output - Yfe (maximum level of output at sustainable levels). The Keynesian model of LRAS believes you can be producing below Yfe.

Question 21

LRAS Determinants

Answer 21

1. The quality/quantity of an economy’s factors of production
2. Competition: businesses will want to reduce their costs as much as possible to stay competitive therefore more productive so quality of labour ^.
3. Investment

Question 22

LRAS Keyneysian Steps

Answer 22

1. At point A, the price level is low representing there was a recession. Keynesians believe that you can approach Yfe without any inflationary pressure as there is mass unemployment of economic resources so you won’t have to pay extra for them (so wages/capital goods’ price don’t increase so no increase in price level).
2. At point B, we are getting closer to Yfe. This means we are using up more of our spare capacity so costs of production will increase for firms which they will have to raise their prices and thus causing inflationary pressure within the economy.
3. At point C, we are now utilising all of our factors of production and it is not possible to sustainably increase output.

Question 23

Marginal Propensity (MPC and MPS)

Answer 23

MPC: Marginal Propensity to Consume is the proportion of a raise in pay that a consumer spends on the consumption of goods/services as opposed to saving it.
Formula: change in Consumption/change in disposable income.

MPS: Marginal Propensity to Save is the proportion of a raise in pay that a consumer saves rather than spending on the consumption of goods/services.
Formula: change in saving/change in disposable income.