Unit 4 - Chapter 16 - Circular flow of income

Question 1

define the circular flow of incom

Answer 1

The circular flow of income model shows how income, spending and output move around an economy. The model shows that output generates income which is then spent on the output.

A simple, two-sector (including households and firms) economy can be illustrated below

Question 2

explain equilibrium in national income

Answer 2

An equilibrium in the national income means there is no tendency for the national income to change.

In a simple, two-sector economy, this occurs when planned saving (or the planned withdrawal of spending) equals planned investment (or the planned injection of spending into the flow) at Y0. In a four-sector economy, this occurs when S+M+T = I + X + G

However, if the withdrawal exceeds the injection, as illustrated below by Y1, the resulting net leakage of spending from the circular flow causes output and income to fall, and subsequently further reductions in consumption, output and income until an equilibrium is established again at Y0.

Likewise, if the withdrawal is less than the injection, as illustrated by Y2, the resulting net injection of spending into the economy causes output and income to rise and subsequently further increases in consumption, output and income until output is back at Y0.

Question 3

explain why higher savings are undesirable for an economy （the paradox of thrift)?

Answer 3

Assuming that national income stays unchanged at Y0(并没有更加富裕）,
an increase in savings means there is an increase in leakages from the economy.

Consumption is lower. Some products will be unsold and so production will fall, causing a drop in national income and subsequently further decreases in savings, consumption, output and income until the economy is in equilibrium again at Y1.

At Y1, injections and withdrawals are equal again. Savings are back to its old level and the equilibrium income is lower.

This is also known as the paradox of thrift

Question 4

Define injections

Answer 4

Injections are additions to the circular flow of income. They include investment, government spending and spending by foreigners on a country’s exports (export revenue).

Question 5

Define withdrawals (leakages)

Answer 5

Leakages are withdrawals from the circular flow of income. They include savings, taxation (both direct and indirect) and import expenditure

Question 6

Define open, four-sector economy

Answer 6

Open, four sector economy: an economy with foreign trade. The economic agents involved are households, firms, government and foreigners.