The Determination of National Income

Question 1

define ‘the circular flow of income’

Answer 1

the flow of receipts and expenditure between companies and households.

Question 2

Diagramm of the circular flow of income in closed economies.

Answer 2

households - get income for supplying the factors of production to a firm

leakages: tax to the government
savings to the banks

firms - get income from spendings on their outputs by households

injections: government expenditure
investment from banks

Question 3

Diagramm of the circular flow of income in open economies.

Answer 3

households - get income for supplying the factors of production to a firm

leakages: tax to the government
savings to the banks
imports from foreign markets

firms - get income from spendings on their outputs by households

injections: government expenditure
investment from banks
exports to foreign markets

Question 4

formula for a firms income (Y)

Answer 4

Y = C + I + G + (X - M)

consumption, investment, government current expenditure, exports, imports

Question 5

what is the average propensity to consume?

Answer 5

the proportion of total income spent.

Question 6

formula for the average propensity to consume!

Answer 6

APC = total consumption divided by total income

Question 7

what is the marginal propensity to consume?

Answer 7

the proportion of each additional unit of income that is spent.

Question 8

formula for the marginal propensity to consume!

Answer 8

MPC = change in consumption divided by change in income

Question 9

what does consumption depend on?

Answer 9

1. level of income, irrespective of source
2. availability of credit
3. rate of interest (opportunity cost of spending)
4. Rate of income taxation

Question 10

what does investment depend on?

Answer 10

1. cost of capital goods
2. businesspeople’s expectations
3. government expenditure
4. productive capacity of the economy
5. state of technology

Question 11

what do exports depend on?

Answer 11

1. levels of income abroad.
2. competitiveness
3. value of the euro

Question 12

what do imports depend on?

Answer 12

1. availability of goods
2. foreign prices vs. domestic prices
3. levels of incomes (irrespective of source)
4. value of the euro
5. marginal propensity to import (MPM)

Question 13

formula for the marginal propensity to import!

Answer 13

MPM = change in imports divided by change in income

Question 14

define the marginal propensity to import (MPM) !

Answer 14

the proportion of each additional unit of income that is spend on imports.

Question 15

what is the multiplier ?

Answer 15

shows the precise relationship between an initial injection into the circular flow of income and the eventual increase in national income resulting from the injection.

Question 16

what is the multiplier effect?

Answer 16

a change in spending will cause a change in national income, but the change in income is likely to be much greater than the initial expenditure.

Question 17

formula for the multiplier!

Answer 17

1 divided by 1- MPC

or

1 divided by MPS

…shows the precise relationship between an initial injection into the circular flow of income and the eventual total increase in national income resulting from the injection.

… developed by John Maynard Keynes

Question 18

what is meant by the ‘marginal propensity to save’ ?

Answer 18

the percentage of savings held out of the last increase in income

i.e. if you don’t spend money (or pay tax) you must save it.

Question 19

formula for the marginal propensity to save !

Answer 19

MPS = 1 - MPC

Question 20

Factors that affect the savings rate in the Irish economy .

Answer 20

1. Futur expectations for the economy
2. security of savings
3. price levels / real rate of interest
4. quality of financial products
5. future levels of state benefits
6. deferred spending (i.e 1)

Question 21

what are economic effects that an Increase in the rate of savings may have on the Irish economy.

Answer 21

1. reduced spending
2. increased level of funds available for investment
3. reduced inflation
4. reduced demand for imports
5. more capitalized banks
6. increased revenue for government

Question 22

what are transfer payments?

Answer 22

payments received for which no factor of production has been supplied or offered.

income people received for which they did not supply goods or services.

Question 23

what are the impacts of transfer payments on the multiplier?

Answer 23

the receiving person has a high MPC and spends more.

the use of transfer payments actually speeds up the pace at which money moves in the economy and this has a positive impact.

Question 24

what are the impacts of shocks on the economy or circular flow of income?
(give case studies as examples)

Answer 24

case study 1 : 
a sudden rise in the price of oil.
-no choice of a substitute 
-large leakage
-lower economic activity

case study 2 :
a factory closure
-staff loses jobs
-incomes fall
-government receives less tax
-if the factory was exporting their goods, there is an additional loss of an injection

Question 25

the Keynesian presentation of national income

Answer 25

45 C diagram to illustrate consumption at different levels of income

Question 26

what is a trade circle ?

Answer 26

refers to recurring patterns of expansion and contraction in the economy.

… provides information on the relationship between prices, employment and investment

i.e. almost all the major industrialized economies of the world have experienced a continuous succession of booms and slumps.

Question 27

briefly name the 5 phases of the trade cycle!

Answer 27

1. recovery
2. boom
3. recession
4. depression
5. back to the beginning of the cycle

Question 28

explain phase 1 of the trade cycle (recovery)

Answer 28

the economy starts from a depressed state (high unemployment, low prices and output)

an increase in investment with the multiplier effect leads to increased incomes and demand.

this increased level of demand leads to a further increase on investment capital, anticipating future profits.

this leads to increased economic activity and recovery.

Question 29

explain phase 2 of the trade cycle ( boom)

Answer 29

as demand increases , the level of employment increases.

any further increases in demand can not be satisfied by increases in production.

leads to price increases via inflation

Question 30

explain phase 3 of the trade cycle (recession)

Answer 30

the boom comes to an end

output is at its full capacity and investment begins to decrease.

fall in consumption

profits and prices fall - wave of pessimism

demand for new capital equipment falls

Question 31

explain phase 4 of the trade cycle (depression)

Answer 31

occurs only in extreme circumstances.

very deep fall-off of economic activity

when a recession has persisted for an extended period of time and the economy has seen a real decline of GDP by more then 10%.

Question 32

what are the positive consequences of economic growth?

Answer 32

increases employment,

improved government finances,

effect on balance of payment,

improved standard of living,

effects on migration,

investment opportunities

Question 33

what are the negative consequences of economic growth?

Answer 33

inflationary pressures,

labour shortages,

damand for wages increases,

increased demand for imports,

pressure in the housing market,

increased immigration/displacement of population.

pressure on state infrastructure

Question 34

what is the accelerator principle?

Answer 34

…states that an increase in demand for final goods results in a more than proportional increase in demand for capital goods.

Question 35

what do you know about John Maynard Keynes ?

Answer 35

1883-1946
his mayor work: The General Theory of Employment, Interest and Money

output is demand determined

the multiplier

government intervention 
(laissez-faire thinking)

liquidity preference Theory
(transitionary, precautionary, speculative )

national Y could be in equilibrium at less than full employment

investment decisions by entrepreneurs