2.4 - National income

2 types of economy

Closed economy - Doesn’t rely on foreign earnings

Open economy - Open to foreign earnings

Circular flow of income

Households supply the factors of production in exchange for income.

The households spend the income on goods and services produced by the firm - National income

The firms use the factors of production provided to produce goods and services - National output

The money is passed from firms to households

Income method

Firms provide rewards to households in exchange for factors of production

Land - Rent

Labour. - Wages

Capital - Interest

Enterprise. - Profits

Output method

Firms produce goods and services for households

Expenditure method

Households spend income on goods and services, this money goes back to firms

Evaluation of the circular model of income

Assumes every pound generated is spent

The government is not included

Government takes money out by taxation and puts money in through spending

Ignores

Withdrawals - Savings, imports, tax

Injections - Reinvestment, Exports, Gov spending

Circular flow of income analysis

Injections > Withdrawals - Economic growth

Injections < Withdrawals - Economic decline

Injections = Withdrawals - Equilibrium

What is a multiplier

An initial injection into the circular flow creates a larger final increase in real national income

What is the equilibrium position of national output

Is where AD and AS intersect

Short term analysis

A shift in SRAS to the right would cause a fall in average price level, but an increase in RGDP

A shift to the right of the AD curves would cause a ruse in average price level, and a rise in RGDP

LRAS

classical - since the LRAS curve is inelastic, a shift in SD would just cause inflation

The economy will always return back to full employment

An increase in AD will lead to disequilibrium as this means the economy is operation at over full capacity

So supply then shifts to the left to move back to LRAS which is the same initial output but at a higher price

Keynesian LRAS

Why do keynesians argue that during recessions governments need to use demand side policies and not supply side policies

As during a recession, then an increase in LRAS won’t do anything for price or output

What does the size of the multiplier depend on

How much of an increase in incomes will people spend (MPC)

Effects of the multiplier on the economy

The multiplier means that growth can occur quicker as any injections can lead to a bigger increase in national income

Injections can be targeted to those with the biggest MPC ( those on lower incomes)

Increase in gov spending - increase AD, INCREASE IN RGDP, increase in economic growth

Increase in national income - demand pull, and cost push inflation

Increase in national income - increase in spending, increase job creations, increase consumption and investment

Evaluation

It is difficult for the government to know the size of the multiplier

Depends on MPW

There is a time lag between income and full effect of multiplier as not everyone will spend the money right away

Depends of change in AD and the elasticity of the AS curve

Leads to inflation which will increase interest rates which will increase the marginal propensity to import

Must be enough spare capacity

Income

A flow concept, representing a flow of money

Wealth

A stock concept, the sum of all assets in an economy