Circular Flow Economy

Question 1

Who are the 2 decision-makers in a closed economy?

Answer 1

1. Households

2. Firms

Question 2

What is the function of a household in a closed economy?

Answer 2

Households are the owners of the four factors of production: land, labor, capital, and entrepreneurship

Question 3

What is the function of a firm in a closed economy?

Answer 3

Firms buy the factors of production in resource markets and use them to produce goods and services, which are then sold to households in product markets

Question 4

What is household income?

Answer 4

When households sell their factor of production to firms in the resource markets

Question 5

What are the four forms of household income?

Answer 5

1. Rent (for land)
2. Wages (for labour)
3. Interest (for capital)
4. Profit (for entrepreneurship)

Question 6

What is household expenditure?

Answer 6

When households buy goods and services from firms in the product markets

Question 7

What are costs of production?

Answer 7

When firms purchase factors of production from households in the resource markets

Question 8

What is revenue?

Answer 8

When firms sell their goods and services to households in the product market

Question 9

What is the significance of a circular flow of income model?

Answer 9

The circular flow of income shows that in any given time period, the value of output produced in an economy is equal to the total income generated in producing that output (as to earn income, one must sell goods/services)

Question 10

What are leakages?

Answer 10

Any income earned but NOT spent on goods and services does not represent the value of a nation’s output

Question 11

What are injections?

Answer 11

Additional value added to an economy from a source other than households or firms

Question 12

What are the 3 types of leakages?

Answer 12

1. Government Taxes
   - reduces household income
2. Household expenditure on foreign goods (i.e. imports)
   - Does not represent value of output produced by country
3. Savings
   - Decreases household expenditure

Question 13

What are the 3 types of injections?

Answer 13

1. Government spending
   - increases value of output apart from household expenditure
2. Foreign purchase of national output (i.e. export)
   - increases value of output apart from household expenditure
3. Loans provided to firms by banks (i.e. investments)
   - firms obtain money apart from revenue gained

Question 14

What are the 3 outcomes if sum of leakages > sum of injections?

Answer 14

1. Production of goods and services decreases
2. Household income decreases
3. Unemployment increases

Question 15

What are the 3 outcomes if sum of injections > sum of injections?

Answer 15

1. Production of goods and services increases
2. Household income increases
3. Unemployment decreases

Question 16

What happens if savings > investment?

Answer 16

1. Fewer goods and services are being produced as disposable income is low, resulting in low investment
2. Firms cut back on their output due to low demand, lowering investment and buying fewer factors of production
3. Results in a reduction of household income and increase in unemployment

Question 17

What happens if exports > imports?

Answer 17

1. Demand for national output increases
2. Firms buy more factors of production
3. Results in an increase of household income and a decrease in unemployment