2.4 National Income (Edexcel A Level Economics A)

False.

National income can be calculated using both the income approach and expenditure approach.

The four factors of production are land, labour, capital and enterprise.

Injections are the additions of money into the circular flow of income that increase national income.

Withdrawals are the leakages of money from the circular flow of income that reduce national income.

The three types of injections are

• increased government spending (G)

• increased investment (I)

• increased exports (X).

The three types of withdrawals are

• increased savings by households (S)

• increased taxation by the government (T)

• increased import purchases (M).

When injections are greater than withdrawals, net positive injections increase economic growth.

When withdrawals are greater than injections, net negative withdrawals lead to a fall in economic growth.

An increase in interest rates increases savings (a withdrawal) and reduces consumption and investment (an injection). This reduces the circular flow of income.

False.

Injections only lead to economic growth if they are greater than withdrawals.

The positive multiplier effect is when the economy grows by a greater amount than the size of the initial injection. For example, an increase in investment will stimulate further rounds of spending.

Increased government spending is an injection that can lead to a rise in the circular flow of income.

Increased spending on imports is a withdrawal that can lead to a fall in the circular flow of income.

The size of the multiplier is influenced by:

• the marginal propensity to consume (MPC)

• the marginal propensity to save (MPS)

• the marginal propensity to import (MPM)

• the marginal propensity to tax (MPT).

Real national output equilibrium occurs when the aggregate demand curve intersects with the aggregate supply curve. It is where AD is equal to AS.

Classical economists believe the economy will always return to its full potential level of real national output in the long-run. All resources will be fully and efficiently employed.

Keynesian economists believe that the economy can still operate below full employment even in the long-run.

In the classical model the LRAS curve represents the maximum possible output of an economy using all of its scarce resources fully and efficiently.

True.

In the Classical model real national output equilibrium always occurs at full employment.

The Keynesian LRAS curve is price elastic at lower price levels whereas the Classical LRAS curve is vertical. It is always perfectly price inelastic at all price levels.

The following changes to the components of AD cause the AD curve to shift:

• Consumption (C)

• Investment (I)

• Government spending (G)

• Net trade (X-M)

Changes to the determinants of SRAS cause the SRAS curve to shift:

• Costs of production

• Changes in exchange rates

• Changes in tax rates

An increase in AD in the classical model leads to higher price levels and real national output in the short-run.

An increase in the LRAS in the Classical model leads to lower price levels and higher real national output.

A negative output gap is when the equilibrium of real national output is below the full employment level of real national output.

The Keynesian model explains price stickiness as an inability to adjust prices and wage rates quickly to a change in macro-economic conditions.

The multiplier ratio is the size of the change in real income in relation to the size of the injection that created the change.

The multiplier process works through generating further rounds of spending. One person's spending becomes another person's income.

The size of the multiplier is affected by the size of the withdrawals from the circular flow of income that occur during the process:

• Savings (S)

• Taxes (T)

• Imports (M)

Marginal propensity to consume is the proportion of additional income that is spent.

Marginal propensity to save is the proportion of additional income that is saved.

Marginal propensity to tax is the proportion of additional income that is paid in tax.

Marginal propensity to import is the proportion of additional income that is spent on imports.

The multiplier in terms of the MPC is calculated using the formula

The multiplier in terms of the withdrawals is calculated using the formula

An increase in tax rates reduces the value of the multiplier.

An increase in interest rates reduces the value of the multiplier. It increases the incentive to save and decreases consumption as borrowing is more expensive.

False.

The multiplier effect takes time as further rounds of spending work through the economy.