2.4. National Income

Question 1

In the most basic circular flow of income model, what two sectors are included?

Answer 1

Households and firms.

Question 2

What do households provide to firms in the circular flow of income model?

Answer 2

Land, labor, and capital.

Question 3

In return for providing factors of production, what do firms provide to households?

Answer 3

Rent, wages, interest, and profits.

Question 4

In a simple two-sector model, what are the three ways of measuring economic activity?

Answer 4

National output, national expenditure, and national income.

Question 5

In a simple two-sector model, how are national output, national expenditure, and national income related?

Answer 5

They are equal: national output = national expenditure = national income.

Question 6

Besides households and firms, what other sectors can be added to the circular flow of income model?

Answer 6

The government, financial services, and foreign markets.

Question 7

How does the government affect the circular flow of income?

Answer 7

Through taxation (T) and government spending (G).

Question 8

How do financial services affect the circular flow of income?

Answer 8

Through investment (I) and savings (S).

Question 9

How do foreign markets affect the circular flow of income?

Answer 9

Through exports (X) and imports (M).

Question 10

Define ‘wealth’ in economic terms.

Answer 10

A stock of assets.

Question 11

Define ‘income’ in economic terms.

Answer 11

A flow of money.

Question 12

Give examples of wealth.

Answer 12

Houses, possessions.

Question 13

Give examples of income.

Answer 13

Money from work, interest from savings.

Question 14

What are injections in the economy?

Answer 14

Monetary additions to the economy.

Question 15

Give examples of injections.

Answer 15

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

Question 16

What are withdrawals (or leakages) from the economy?

Answer 16

Where money is removed from the economy.

Question 17

Give examples of withdrawals (or leakages).

Answer 17

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

Question 18

What happens to the economy if the sum of injections is greater than the sum of withdrawals?

Answer 18

The economy will be growing.

Question 19

What happens to the economy if the sum of injections is smaller than the sum of withdrawals?

Answer 19

The economy will be shrinking.

Question 20

In equilibrium, how are injections and withdrawals related?

Answer 20

Injections must be equal to withdrawals.

Question 21

How is the equilibrium level of national output determined?

Answer 21

Where the AD and AS curves intersect.

Question 22

According to classical economists, what happens to long-run national output when the AD curve shifts?

Answer 22

It is not affected; only price levels are affected.

Question 23

What do classical economists believe about unemployment in the long run?

Answer 23

There will be no unemployment; the economy will always return to full employment.

Question 24

What is the shape of the classical LRAS curve?

Answer 24

Perfectly inelastic (vertical).

Question 25

According to Keynesian economists, can there be equilibrium at less than full employment?

Answer 25

Yes, they believe the economy can be in equilibrium where the LRAS curve is horizontal.

Question 26

According to Keynesian economists, what should the government do during recessions?

Answer 26

Work to increase Aggregate Demand.

Question 27

What is the multiplier process?

Answer 27

An increase in AD due to an increased injection leads to a further increase in national income.

Question 28

What is the multiplier ratio?

Answer 28

The ratio of the final change in income to the initial change in injection.

Question 29

What is the marginal propensity to consume (MPC)?

Answer 29

The increase in consumption following an increase in income.

Question 30

What is the marginal propensity to save (MPS)?

Answer 30

The increase in savings following an increase in income.

Question 31

What is the marginal propensity to tax (MPT)?

Answer 31

The increase in taxation following an increase in income.

Question 32

What is the marginal propensity to import (MPM)?

Answer 32

The increase in imports following an increase in income.

Question 33

What is the marginal propensity to withdraw (MPW)?

Answer 33

The increase in leakages following an increase in income.

Question 34

What is the relationship between MPW, MPS, MPT, and MPM?

Answer 34

MPW = MPS + MPT + MPM

Question 35

What is the formula for the multiplier?

Answer 35

Multiplier = 1/(1-MPC) or Multiplier = 1/MPW

Question 36

How does the elasticity of the AS curve affect the impact of the multiplier?

Answer 36

The more elastic the curve, the smaller the effect on price and the bigger the effect on output.