Macro 3.2.2 Circular flow of income, aggregate demand/supply

Question 1

define the difference between real and nominal income

Answer 1

real income is adjusting nominal income for inflation

Question 2

define national capital stock

Answer 2

the stock of capital goods such as buildings and machinery that has accumulated over time

Question 3

define circular flow

Answer 3

movement of money between households and firms

Question 4

how many assumption does the basic circular flow of income consist of

Answer 4

consists of 6 assumptions - savings, taxation, imports, exports, gov spending, investment

Question 5

circular flow diagram

Question 6

what are the 4 factors of income

Answer 6

wages, rent, profit, interest

Question 7

define injections and leakages and what are their components

Answer 7

injections - add money to the circular flow of income, which can lead to economic growth (investments, government spending, exports)

leakages/withdrawals - take money out of the circular flow of income, which can lead to to economic slowdown (savings, taxation, imports)

Question 8

what are the components of aggregate demand

Answer 8

investment + consumer spending + gov spending + net exports

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

Question 9

different types of economic growth in the circular flow of income

Answer 9

injection > leakage = increase

injection < leakage = decrease

injection = leakage = macroeconomic equilibrium

Question 10

if injections are greater than leakages, what happens to the size of the economy

Answer 10

the economy grows

Question 11

methods to measure GDP

Answer 11

output: measure value of goods and services
income: measure total value of all factors of income
expenditure: I + C + G + (X-M)

Question 12

what is the two sector circular flow of income model

Answer 12

• economy only consists of two sectors: household and firms
• housholds spends all income(Y) on goods and servcies or consumption(C) - no saving(S)
• all output(O) produced by firms is purchased by households through their expenditure(E) no-disequilibrium
• no financial sector
• no government sector
• no overseas sector

Question 13

what is the concept of equilibrium national income

Answer 13

national income is in equilibrium when planned saving = planned investment

S=I

Question 14

what happens to national income if S>I, S<I, S=I

Answer 14

• S>I rate of national income decreases
• S<I rate of national income increases
• S=I rate of national income is in equilibrium

Question 15

what is the multiplier effect

Answer 15

• when an initial injection into the cirular flow causes a bigger final increase in real nation income

• additional amount of AD injected after inital injection
• one persons spending is another persons income
• injection demand may come from rise in exports, investment or gov spending

Question 16

how to calculate the multiplier effect

Answer 16

• overall increase AD / initial injection
• 1 / 1 - MPC

Question 17

define MPC and how to calculate

Answer 17

• every additional pound paid how much will be used for consumption
• change in spending / change in income

Question 18

what does aggregate demand mean

Answer 18

total demand of goods and services within a particular market

Question 19

what are the components of aggregate demand

Answer 19

government spending + consumption + investment + net exports

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

• increase in any of the components will cause a rightward shift in AD
• decrease in any of the components will cause leftward shift in AD

Question 20

how does interest rates affect consumption

Answer 20

low interest rates mean people will borrow more which increases consumption

Question 21

what are the 6 determinants of saving

Answer 21

1. level of real disposable income
2. interest rates - high interest encourage more savings so less consumption
3. consumer confidence
4. range/trustworthiness of financial invitations
5. tax incentives - ISAS encourage more savings
6. age strucutre of population - younger and older people will have a high MPC

Question 22

what 4 factors influence investment decisions

Answer 22

1. Relative prices of capital and labour - investment may increase if prices of capital and labour are cheaper as businesses MPC will increase as it will help save them money and decrease their costs
2. Technological process - invetsment may increase due to busiensses needing new advanced technolgoy which enables them to be more competitive and efficient
3. Adequacy of fincancial instituions to supply invetsment funds - business are less liekly to put money into the bnaks due to a alck of confidence from the business so they are more liekly to invest
4. Government funding - the government are funding more into various sectors investment from business will increase as it can be seen as more prfoitbale for them
5. Outline the accelerator effect - an increase in national income (GDP) results in a proportionaly larger rise in capital investment spending

Question 23

define the multiplier and its formula

Answer 23

• the multiplier process and an explanation of why an inital change in expenditure may lead to a larger impact on local or national income

Multiplier (k) = change in real GDP (Y) / change in injections (J)

Question 24

define aggregated supply (AS)

Answer 24

total supply of goods and services available to a particular market from producers

Question 25

what are the determinants of SRAS

Answer 25

1. wages 2. raw material / commidity prices 3. oil price 4. business taxes (VAT) 5. imports prices (SPICED/WIDEC)

Question 26

what factors affect the SRAS curve

Answer 26

a shift will be cuased by any factor that leads to chnages in the firms costs of production

Question 27

what is reflation

Answer 27

* fiscal or monetary policy designed to expand output, stimulae spending and curb the ffects of deflation * usually occurs after a period of economic uncertainty or a recession

Question 28

what are the determinants of LRAS

Answer 28

* technology * productivity * attitudes * enterprise * facotr mobility * economic incentives

Question 29

what causes a shift in the LRAS

Answer 29

increase or decrease in the quantity or quality of capital, enterprise, land or labour | Q squared cell

Question 30

traditional left wing policies to shift LRAS

Answer 30

* **government intervention to improve infrastructure**, improve quality causing shift in LRAS * **globalism**, increased quanitity or land and labour * **redistribute wealth** like inheritance tax, increase quanitiy of entrepreneurs * **increase innervation**, increase quantity of capital * **investment in education**, increase quanitity labour as more people skilled * **investment into healthcare**, improve quality and quantity of labour so can produce more

Question 31

traditional right wing policies to shift LRAS

Answer 31

* **encourage entrepreneurial spirit** so lower corporation tax so more people set up business * **protectionism**, anti immigration to protect domestic industries so increased quality of capital in own country * **free market**, increased quantity of capital * **lower minimum wage** so business encouage to increase quantity of labour * **personal income tax reduce**, increase disposable income so increase quanitity of entrepreneurhsip as more cahs to start business * **lower welfare state**, increase quantity of labour as more people get jobs

Question 32

why might governments offer subsidies to firms to encourage the production of renewable energy sources

Answer 32

renewable energy are positive externalities which the government want to encourage as this will benefit society, governments will introduce the subsidies in order to reach the socially optimal point which is were society would rather produce at as it will benefit people