2.4. National Income

What is the basic model of the circular flow of income comprised of?

Households and firms.

In the circular flow model, households provide firms with which resources?

Land, labour, and capital.

What flows in one direction in the circular flow of income model?

Money.

What flows in the opposite direction in the circular flow of income model?

Goods, services, and factors of production.

How are national output, national expenditure, and national income related in the simple two-sector model?

National output = National expenditure = National income.

What does the government take out of the economy through?

Taxation (T).

What can increase the flow of income in the economy?

If the government spends more than it taxes.

What do financial services inject into the economy?

Investment (I).

What do imports (M) do to the flow in the economy?

Take money away from the flow.

What is the difference between income and wealth?

Wealth is a stock of assets; income is a flow of money.

List the injections into the economy.

Government spending (G), investment (I), exports (X).

List the withdrawals from the economy.

Taxes (T), savings (S), imports (M).

What happens if injections are greater than withdrawals in the economy?

The economy will be growing.

What must injections equal for national income to remain the same?

Withdrawals.

Where does the equilibrium position of national output occur?

Where the Aggregate Demand (AD) and Aggregate Supply (AS) curves intersect.

What happens to equilibrium if the AD or AS curves shift?

The equilibrium position will change.

What is the impact of a decrease in SRAS?

Higher prices and lower real GDP.

Classical LRAS is perfectly inelastic; what does this mean?

A change in price has no effect on output.

What occurs in the short run when AD increases according to classical economists?

An increase in prices and output.

What leads to a shift in SRAS to SRAS2?

Increased factor costs due to bidding up wages.

What do classical economists believe about full employment in the long run?

The economy will always return to full employment.

What does an increase in AD lead to in a classical context without an increase in LRAS?

Inflation.

What can an increase in long run aggregate supply lead to?

Lower prices and higher output.

What do Keynesian economists believe about equilibrium and full employment?

Equilibrium can occur at less than full employment.

What is the Keynesian view on the impact of a rise in unemployment?

It does not rapidly lead to a fall in real wages.

During deep recessions, what does a rise in AD lead to according to Keynesians?

Only an increase in output, not prices.

When can a shift in AD lead to changes in both price and output in a Keynesian model?

If the economy is at or near full employment.

What is a significant consequence of increasing aggregate demand?

It can also influence long-run aggregate supply.

What is the multiplier process?

An increase in AD due to injections can lead to a further increase in national income.

What are the factors that determine the size of the multiplier?

The marginal propensity to consume (MPC) and the level of leakages.

What is the IMF multiplier estimate for developed countries?

Around 1.5 in the long run.

What is a negative multiplier effect?

A withdrawal from the economy leading to a further fall in income.

How can the government target its injections to stimulate the economy effectively?

By giving more money to those with the highest MPC.

What are the marginal propensities defined in economic terms?

MPC, MPS, MPT, MPM, MPW.

What will increase in MPT due to a tax change affect?

The marginal propensity to consume (MPC).

How do changes in income affect the marginal propensity to consume (MPC)?

Higher income generally leads to different spending habits, affecting the MPC.

If the increase in government spending is £50,000 and the MPC is 0.9, what will be the increase in national income?

£500,000.

What is needed for the multiplier to have the desired effect?

Sufficient spare capacity in the economy.

If AS is perfectly inelastic, what will be the outcome of the multiplier effect?

It will only increase the price, not output.

What is the relationship between the elasticity of the AS curve and the effect of the multiplier?

More elastic AS leads to a bigger effect on output, smaller on price.