How the macroeconomy works

Question 1

What are the three injections into the circular flow of income?

Answer 1

Investment, government spending, and exports.

Question 2

What are the three withdrawals from the circular flow of income?

Answer 2

Saving, taxation, and imports.

Question 3

In the circular flow of income, INCOME = EXPENDITURE = OUTPUT.

Answer 3

In the circular flow of income, INCOME = EXPENDITURE = OUTPUT.

Question 4

How do firms and households interact in the circular flow of income?

Answer 4

Households to firms: Households provide labour for firms, and consumer spending
Firms to households: Firms provide wages and income to households, and goods and services

Question 5

What is aggregate demand?
How can it be calculated?

Answer 5

Aggregate demand is the total demand in the economy.
AD = C + I + G + (X - M), where C is consumption, I is investment, G is government spending, and (X - M) is net exports.

Question 6

What is aggregate supply?
What are the two types of AS?

Answer 6

Aggregate supply is the total supply in the economy.
AS can be short run (SRAS) or long run (LRAS).

Question 7

What shifts SRAS?

Answer 7

Changes in costs of production.

Question 8

What shifts LRAS?

Answer 8

As LRAS shows the procutive potential of the economy, it can be shifted by changes in the quantity or quality of CELL.
This is equivalent to a shift in the PPF curve.

Question 9

What is consumption?

Answer 9

The total amount spent on goods and services by consumers, making up over 60% of AD. The money spent on consumption is a consumers disposable income (money left after taxes).

Question 10

What are the sources of income for consumers?

Answer 10

Wages, rents, dividends, savings, pensions, benefits and investments.

Question 11

What is marginal propensity to consume?

Answer 11

MPC is how much a consumers spending changes with a change in income.
MPC + MPS = 1

Question 12

What is marginal propensity to save?

Answer 12

MPS is the proportion of each extra pound of household income that is saved.
MPC + MPS = 1

Question 13

What may affect consumption?

Answer 13

Interest rates and consumer confidence.

Question 14

What may affect investment?

Answer 14

1. Rate of economic growth.
2. Interest rates.
3. Business confidence and expectations.
4. Demand for exports.
5. Availability of credit.
6. Government influence and regulations.

Question 15

What is the accelerator effect?

Answer 15

An increase in GDP is likely to lead to an increase in investment.

Question 16

What is government spending?

Answer 16

The amount the government spends on state supplied goods and services.

Question 17

What may affect government spending?

Answer 17

The economic cycle and fiscal policy.

Question 18

What are net exports?

Answer 18

The total value of exports minus the total value of imports.

Question 19

What may affect net exports?

Answer 19

1. Exchange rate.
2. Real income.
3. State of world economy.
4. Degree of protectionism (tariffs, quotas…).
5. Non-price factors e.g. competitiveness.