How the Macroeconomy Works

Question 1

What is national income

Answer 1

National income is the total value of the goods and services a country produces. It is the output in one year.

Question 2

Explain the circular flow of income and state the 3 injections and withdrawals

Answer 2

Firms and households interact and exchange resources in an economy.
Households supply firms with the factors of production, such as labour and capital, and in return, they receive wages and dividends.
Firms supply goods and services to households. Consumers pay firms for these.
This spending and income circulates around the economy in the circular flow of income

Injections:
Investment
Govt. Spending
Exports

Withdrawals:
Savings
Taxes
Imports

Question 3

What is the equation of the circular flow of income

Answer 3

income = output = expenditure

Question 4

How does the difference in withdrawals and injections affect the economy

Answer 4

When withdrawals = injections
Economy is in equilibrium
When withdrawals > injections
Contraction of production, so output decreases
When withdrawals < injections
Expansion of national output

Question 5

What are the components of AD

Answer 5

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

Question 6

What does LRAS show that SRAS doesn’t

Answer 6

The potential supply of an economy at full employment of factors of production

Question 7

What is the accelerator effect

Answer 7

o The accelerator effect suggests that the level of investment in an economy is
related to the change in GDP. A higher rate of economic growth causes more investment.
o If the rate of economic growth is slowing, but the economy is still growing, the level of investment might fall.
o The level of investment is more volatile than the rate of economic growth.

Question 8

What is the multiplier effect

Answer 8

The multiplier effect occurs when there is new demand in an economy. This leads to an injection of more income into the circular flow of income, which leads to economic growth. This leads to more jobs being created, higher average incomes, more spending, and eventually, more income is created.

Question 9

What factors influence SRAS (5)

Answer 9

• The cost of employment might change, e.g. wages, taxes, and labour productivity. If costs increase, supply will shift inwards from SRAS1 to SRAS3.
• The cost of other inputs e.g. raw materials, commodity prices, and the
  exchange rate if products are imported. A stronger currency reduces the price of imports, so imported products will be cheaper. This would shift the AS curve outwards, from SRAS1 to SRAS2.
• Government regulation or intervention, such as environmental laws or green taxes and business regulation. Business regulation is sometimes called ‘red tape’.
• There could be a net outward migration of workers, which causes a ‘brain drain’ on the domestic economy, as skilled workers move.
• If there is a fall in business capital spending, supply will fall.

Question 10

What factors influence LRAS (6)

Answer 10

Technology advances
Changes in relative productivity
Changes in education and skills
Changes in govt. regulation
Demographic changes and migration
Competition policy