2.4 Flashcards
(18 cards)
What is the circular flow of income?
Shows how income flows between households and firms
-Households provide firms with land, labour, capital and expenditure
-Firms provide households with rent, wages and goods/services
What is wrong with the circular flow of income model?
It is too simplified
-Government spending needs to be added
-Investment and savings needs to be added
What is the difference between wealth and income?
Wealth is a stock of assets whilst income is a flow
Wealth is the things people own whilst income is the money people receive
What is the formula for injections and withdrawals?
I + G + X = S + T + M
What is the relationship between injections and withdrawals?
If injections > withdrawals = Economic growth increases
If withdrawals > injections = Economic growth decreases
Where is the equilibrium level of output?
Where AD and AS intersect
When do negative and positive output gaps occur?
Negative output gaps occur when actual output is less than potential output
-LRAS must be to the right of the equilibrium point
Positive output gap occurs when actual output is greater than potential output
-LRAS must be to the left of the equilibrium point
What do classical economists believe about long run equilibrium?
That the economy will always return to its full potential level of output
What do Keynesian economists believe about long run equilibrium?
The economy can be in long-run equilibrium at any level of output
Keynesians believe there can be equilibrium at less than full employment because they don’t believe rise in unemployment rapidly leads to a fall in wages
In the short term (SRAS) what is the result of a change in SRAS and AD?
SRAS:
Increase in SRAS causes a fall in price level and increase in real GDP
Decrease in SRAS causes higher prices and fall in GDP
AD:
Increase in AD results in higher prices and higher output
Decrease in AD results in low prices and low output
Classical: In the long term (LRAS) what is the result of a change in SRAS and AD?
Shift of AD wouldn’t affect LRAS and only affect price levels. Classical economists believe economy will always return to full employment level
AD increasing will increase price / output in short run but overtime prices will continue to rise. The only way to increase output is to increase LRAS.
Classical: what is the effect of a shift in LRAS?
Increase in LRAS causes lower prices and higher output only when the economy is at or near full employment
If economy is in deep recession, an increase in LRAS will have no effect on price or output
What is the multiplier ratio?
Final change in income : Initial change in injection
What is the multiplier process?
The idea that an increase in AD because of increased injections leads to an increase in national income
The size of the multiplier is determined by the increase in MPC
Low leakages, high MPC, high multiplier
Whare are the effects of the multiplier on the economy?
Growth occurs quicker
-Injections lead to bigger increase in national income
-Injections targeted at those with biggest MPC increases size of multiplier more
Time lag between increase in income and full effect of that increase as not everyone will spend money straight away
What are the effects of marginal propensities and the multiplier?
MPC - increase in income causes increase in consumption
MPS - increase in income causes increase in savings
MPT - increase in income causes increase in taxation
MPM - increase in income causes increase in leakages
When MPC increases, multiplier increases
When MPS or MPT or MPM increases, multiplier decreases
Formula for multiplier
1 / 1 - MPC OR 1/MPW where MPW = MPS + MPT + MPM
Effects of multiplier on change in AD
The multiplier will have a big effect when there is plenty of spare capacity in the economy and the MPW is low/MPC is higher. It has little effect on output when there is little spare capacity in the economy so the rising demand only creates rising prices.
