3.1 (Part 2) circular flow and ad/as model

Question 1

circular flow of income

Answer 1

The Circular Flow of Income is the movement of income and payments between the different economic agents (namely households, firms, banks, government, and in an open economy, the external sector). It shows how an economy arrives at a certain equilibrium level of income.

Question 2

withdrawals

Answer 2

Withdrawals (W) are parts of income that are not passed on within the circular flow of income and therefore will not stimulate the creation of further economic activities and incomes. examples are savings, taxes, and import expenditure. W = S + T + M

Question 3

injections

Answer 3

Injections (J) refers to the addition to the circular flow of income that does not come from the expenditure of the households (ie consumption expenditure). examples are investment, government expenditure and export revenue. J = I + G + X

Question 4

aggregate demand

Answer 4

Aggregate demand (AD) is the total demand of an economy’s domestically produced final goods and services at a given general price level, in a given time period

Question 5

consumption expenditure (C)

Answer 5

Consumption expenditure (C) refers to household’s expenditure on final goods and services by households

Question 6

investment expenditure (I)

Answer 6

investment expenditure (I) refers to firms’ expenditure on capital goods (machines, factories and equipment) which will allow for increased production of consumer goods and services in future time periods

Question 7

foreign direct investment (FDI)

Answer 7

Foreign Direct Investments (FDI) refers to the spending by foreign firms on capital goods that are located within the domestic boundaries of a country

Question 8

Government expenditure (G)

Answer 8

Government expenditure (G) is the total spending by the government on goods and services as well as capital goods. Government expenditure can generally be categorised into operating expenditure and development expenditure

Question 9

Export revenue (X)

Answer 9

Exports revenue (X) is the total expenditure by foreigners on domestically produced goods and services

Question 10

Import expenditure (M)

Answer 10

Import expenditure is the total expenditure by domestic firms, households and the government on foreign goods and services

Question 11

Aggregate supply (AS)

Answer 11

Aggregate supply (AS) refers to the total supply of an economy’s domestically produced final goods and services at a given general price level in a given time period

Question 12

the multiplier effect

Answer 12

the multiplier effect states that whenever there is an injection or withdrawal that causes a change I any component of AD, there is likely to be a multiplied effect on real GDP

Question 13

the multiplier (k)

Answer 13

the multiplier (k) indicates the number of times real national income (Y) changes relative to an initial change in autonomous expenditure
multiplier (k) = 1/(1-MPC) = 1/MPW

Question 14

marginal propensity to consume (MPC)

Answer 14

marginal propensity to consume (MPC) is the proportion of additional income spent on consumption

Question 15

marginal propensity to withdraw (MPW)

Answer 15

marginal propensity to withdraw (MPW) is the proportion of additional income that is withdrawn from the circular flow of income, in the form of savings, taxes and imports. MPW = MPM + MPT + MPS

Question 16

marginal propensity to save (MPS)

Answer 16

marginal propensity to save (MPS) is the proportion of additional income that is saved

Question 17

marginal propensity to import (MPM)

Answer 17

marginal propensity to import (MPM) is the proportion of additional income that is spent on imports

Question 18

marginal propensity to tax (MPT)

Answer 18

marginal propensity to tax (MPT) is the proportion of additional income that is taxed