3.1 Circular Flow of Income Model + Intro

Question 1

in terms of macro

studies

Answer 1

study of aggregate economic activity. It investigates how the economy as a whole works.

Question 2

in terms of macro

short run

Answer 2

The period of time when the prices of factors of production, especially wages, are considered fixed.

Question 3

in terms of macro

long run

Answer 3

The period of time when the prices of all* factors of production*, especially wages, change to match changes in the price level.
* It is important to realise that the long run in macroeconomics is dependent upon the quantity and quality of resources and level of technology in the economy, thus being independent of the price level.

Question 4

aggregate demand (AD)

Answer 4

The total planned spending on domestic goods and services at various average price levels in a given time period. It is calculated as the sum of consumption (C), investment (I), government spending (G), and net exports (X − M): AD = C + I + G + (X − M).

Question 5

aggregate supply (AS)

Answer 5

The total planned level of output that domestic firms are willing and able to produce at various average price levels over a given time period.

Question 6

business cycle

Answer 6

The short-term fluctuations of real GDP around its long-term trend (or potential output).

Question 7

circular flow of income

Answer 7

• Simplified mdoel
• Movement of income, spending, and output
• Between households, firms, government, financial sector, and foreign sector
• Shows interactions between economic decision makers and how national income is affected by leakages (S, T, M) and injections (I, G, X)

A simplified model that illustrates the continuous movement of income, spending, and output between different sectors of the economy — including households, firms, the government, the financial sector, and the foreign sector. It shows the interactions between economic decision-makers and highlights the role of leakages (savings, taxes, imports) and injections (investment, government spending, exports) in determining national income.

Question 8

what is the 2 sector circular flow model?

Answer 8

A simplified model showing only:
* Households and firms
* Households provide factors of production and receive income
* They spend income on goods/services from firms (consumption)
* Shows basic income and output flow with no government, banking, or trade

Question 9

what is the 5 sector circular flow model?

Answer 9

An extended model including:
* Households, firms, government, financial sector, foreign sector
* Adds leakages: savings, taxes, imports
* Adds injections: investment, government spending, exports
* More realistic representation of an open economy

Question 10

what are the 2 main flows in the circular flow model?

Answer 10

Real flow: physical flow of resources and good/services, e.g. land, labour, goods produced. moves in one direction and represents actual economic activity.

Monetary flow: flow of money in exchange for real resources or goods, e.g. wages, rent, consumption spending. Moves in the opposite direction to real flow. Represents the financial transactions behind it (economic activity).

Question 11

what does a PPC model show?

Answer 11

showing actual growth and growth in production possibilities. The maximum combinations of two goods/services an economy can produce with its available resources and technology.
* Actual Growth: Movement inside the curve, indicating more efficient use of resources (e.g., more labor used).
* Growth in Production Possibilities: Shift outward of the curve, indicating an increase in productive capacity (e.g., due to technological advancement or more resources).

Question 12

national income accounting

Answer 12

The services provided by a statistical entity in every country that measure the economy’s national income and output as well as other economic activity.

Question 13

national income statistics

Answer 13

The statistical data used to measure a nation’s income and output, and perform national income accounting.

Question 14

national income

Answer 14

The total income earned by the factors of production in an economy, including wages, interest, rent, and profits. It can be measured using three approaches: the income approach, the expenditure approach, and the output (or production) approach. National income reflects the total economic output and is a key indicator of a country’s economic performance.

Question 15

households

Answer 15

Groups of individuals in an economy who share living accommodation, pool their income, and jointly decide the set of goods and services to consume. Households are the main consumers in an economy, and their spending decisions drive demand for goods and services, influencing production and economic activity.

Question 16

Firms

Answer 16

Productive units in the economy that transform inputs (factors of production) into output (goods and services), usually aiming at earning profits.

Question 17

leakage

Answer 17

Income that is not spent on domestic goods and services and is instead diverted out of the circular flow of income. It includes savings, taxes, and import expenditure. Leakages reduce the overall demand for goods and services in the economy, potentially slowing down economic activity.

Question 18

injections

Answer 18

In the circular flow of income model, injections refer to spending on domestic output that does originate from households. The spending enters the economy and adds to the total demand for goods and services. These include investment spending by firms, government spending, and exports. Injections stimulate economic activity by increasing overall demand and contributing to higher production and income levels.

Question 19

consumption

Answer 19

Spending by households on goods and services over a specific period of time. This includes spending on both durable goods (e.g., cars, appliances) and non-durable goods (e.g., food, clothing), as well as services (e.g., healthcare, entertainment). Consumption is a key component of aggregate demand and is influenced by factors such as income, interest rates, and consumer confidence.

Question 20

foreign sector

Answer 20

In an open economy, the foreign sector refers to the external part of the economy that engages in international trade. It includes export revenues, earned by selling domestic goods and services to foreign buyers, and import expenditures, spent on purchasing goods and services from other countries. The foreign sector plays a key role in the economy by influencing aggregate demand and contributing to the circular flow of income through trade.

Question 21

government spending

Answer 21

Refers to all spending by the government on goods, services, and transfer payments within an economy. Government spending is categorized into:
* Current Expenditures: Spending on day-to-day goods and services, such as salaries of government employees and public services.
* Capital Expenditures: Spending on long-term investments, such as infrastructure projects (roads, schools, etc.).
* Transfer Payments: Payments made to individuals or groups without receiving goods or services in return, such as pensions, unemployment benefits, and social security.

Question 22

income

Answer 22

The flow of earnings from using factors of production (land, labor, capital, and entrepreneurship) to produce goods and services. The main forms of income include:
* Wages and salaries: The income earned by labor for providing services in the production process.
* Interest: The income earned from the ownership of capital, such as investments or savings.
* Rent: The income earned from the ownership of land or natural resources.
* Profits: The income earned by entrepreneurs from their role in organizing production.

Question 23

imports

Answer 23

The value of goods and services purchased (domestically) by residents of a country that are produced in other countries. Imports represent an outflow of spending from the domestic economy to foreign economies.

Question 24

exports

Answer 24

Goods and services that are produced in one country and sold to consumers or businesses in another country. Exports represent an inflow of spending into the domestic economy. They contribute to a country’s aggregate demand and economic growth.

Question 25

net exports (X-M)

Answer 25

The value of a country’s export revenues minus its import expenditures over a given period. It measures the net effect of international trade on aggregate demand.

Question 26

investment

Answer 26

Spending by firms on capital goods (e.g., machinery, tools, equipment, buildings). It is a component of aggregate demand and contributes to economic growth by expanding the economy’s potential output.

Question 27

income approach

Answer 27

One of the three methods of measuring a country’s Gross Domestic Product (GDP). It calculates the total value of output by summing all incomes earned by the factors of production in the economy over a given period—namely wages, profits, interest, and rent.

Question 28

(N/F) expenditure approach

Answer 28

One of the three analytically equivalent methods of measuring a country's Gross Domestic Product (GDP). It calculates GDP by summing all expenditures on final domestic goods and services over a period of time, made by households, firms, the government, and foreign buyers. Expenditure is done by 4 sectors: * Consumption (C): household spending * Investment (I): firm spending on captial goods such as machinery, buildings, and tools. Firms invest mainly to: 1) increase future production (expand capacity) and 2) replace worn-out capital (capital replacement). * Government Spending (G): All spending by local, regional, and national governments on goods and services. Does **not** include transfer payments (e.g., pensions, unemployment benefits, family support) because no good or service is received in return. Two main types: 1) Current expenditures: day-to-day spending (e.g., wages, supplies) 2) Capital expenditures: long-term investment (e.g., infrastructure) * Net Exports (X – M): 1) Exports (X): Spending by foreigners on domestically produced goods and services. 2) Imports (M): Spending by domestic residents on foreign-produced goods and services.

Question 29

output approach

Answer 29

One of the three equivalent ways that GDP can be measured. This meausre of national income adds up the total output of all producers in the economy or the value of **final** goods and services produced in a given time period (intermediate goods are exlucded). Broad categories of producers in the US include for example: mining, utilities (water, electricity, gas), construction, manufacturing, transportation / warehousing, finance / insurance / real estate / rental and leasing services, educational / health care and social assistance services, arts / entertainment / recreation / accommodation and food services.

Question 30

what role does the financial sector play in an economy (or in the circular flow of income model)?

Answer 30

The financial sector is an important element in an economy and will facilitate transactions. When adding the financial sector, you have a five-sector model.

Question 31

what role do households play in an economy (or in the circular flow of income model)?

Answer 31

Households ‘give’ their income to firms in return for actual goods and services. Households expect a good or service in return. In the same way, households do not provide their factors of production and the services from these factors for free; they expect a payment in return. The circular flow of income therefore consists of: wage, interest, rent and profit. The payments of the different factors of production.

Question 32

what role does international trade play in the circular flow of income?

Answer 32

International trade plays an increasingly important role. The value of **exports sold** is **injected** into the circular flow. **Spending by domestic consumers and firms on imported goods and services represents a leakage** from the flow. Goods and services are coming into the economy, but ‘income’ to pay for these is flowing out of the economy.

Question 33

what do investments represent in the circular flow of income?

Answer 33

In addition to consumer spending, firms also carry out spending, but firms would mainly spend on investment in capital goods e.g. on new or faster machinery. Investment is a **monetary injection** into the circular flow of income, as it does not originate from current income. It is ‘new’ income in the flow which is added to the existing flow. Investment in this model is seen as the purchase of capital goods by firms only. Firms may do this to replace worn out capital goods (replacement investment) or to add capacity to the existing stock of capital (net investment).

Question 34

GDP

Answer 34

Gross Domestic Product. The total monetary value of all final goods and services produced within a country's borders in a given time period, typically measured annually or quarterly. GDP measures the overall level of economic activity in an economy. the 3 methods of measuring GDP: 1. Expenditure Approach – Total spending on final goods/services 2. Income Approach – Total income earned by factors of production 3. Output Approach – Total value of final output produced

Question 35

real GDP

Answer 35

The total value of all final goods and services produced in an economy in a given time period (usually one year), adjusted for changes in the price level (inflation or deflation). It reflects the economy’s actual output in constant prices.

Question 36

(n/f) aggregate

Answer 36

In economics, aggregate refers to the total or combined sum of individual units within an economy, such as total output, total demand, or total supply. It is often used to express the collective measurement of an economic variable for the entire economy, rather than individual sectors or elements.