3) Circular Flow Of Income

National income

The flow of new output produced by the economy in a particular period of time. Total value of all goods and services a country produces

National capital stock

The stock of capital goods e.g. machinery, buildings

Nominal National income

NI not adjusted for inflation. Measures flow of output at current price level in economy

Real National Income

NI adjusted for inflation. Is an indicator of current living standards of a country

Limitations of NI this to asses living standards

• the none monetised economy, e.g. housework/diy

• hidden economies and tax evasion

• quality changes of products/services

• negative externalities, e.g. pollution

Limitations of NI to compare between countries

• non monetised economy e.g. housework, diy

• commodities used in and economy e.g. fuel

• exchange rates costs

• non traded goods/services e.g. haircut in India will be cheaper than in England

What is an alternative to National Income?

Purchasing power parity - the rates of currency conversion that equalise the purchasing power of different currencies by eliminating differences in price levels

Advantage and disadvantage of purchasing power parity

Advantage - exchanges are relatively stable over time

Disadvantage - PPP is hard to measure as opposed to market based rates like NI

Methods of calculating NI

• expenditure method - adding up all spending over period of time

• Income method - adding up all incomes earned over period of time

• Output method - value of all output produced in an economy over period of time

Circular flow of income

model of the economy where income and spending flow between households, firms and the govt

Injections

extra money placed into circular flow of income as a result of investment, govt spending and exports

Leakages/ withdrawals

money taken out of circular flow of income due to savings, taxation and imports

if injections > leakages then …

more is being added to the circular flow of income and incomes will rise and level of GDP will rise. The opposite is also true

Macroeconomic equilibrium

the level of national income at which leakages/withdrawals from circular flow of income equal injections into the flow. where AD=AS

Open and closed economy

open economy = an economy open to international trade

closed economy = an economy with no international trade

three leakages from the circular flow of income

savings

imports

tax

three injections into the circular flow of income

investment

exports

government spending