2.4 - national income

• the circular flow of income shows that the output of an economy can be measured in three ways as national output, national expenditure or national income
• injections into the circular flow are investments, government spending and exports
• leakages from the circular flow are savings, taxation and imports
• national output is the value of the flow of goods and services from firms to householders
• national expenditure is the value of spending by households on goods and services
• national income is the value of income paid by firms to households in return for land, labour and capital
• when injections are greater then withdrawals national income will rise
• investment is money spent by firms on capital goods
• transfer payments are payments made by the government which don't contribute directly to output
• wealth is a stock of money whereas income is a flow of money
• nominal figures are not adjusted for inflation whereas real figures are
• an increase in AD would be caused by a fall in interest rates, a fall in the exchange rate and lowering income tax
• a fall in SRAS would be caused by an increase in wages, an increase in the price of raw materials and an increase in taxes on goods and services
• national income measures the monetary value of the flow of output of goods and services produced in an economy over a period of time
• national income is used to measure the rate of economic growth, changes to living standards and changes to the distribution of income
• national output = national expenditure = national income
• according to classical economists there can be no unemployment in the long run as unemployment would cause cuts in wages which would increase the quantity demanded of labour and reduce the quantity supplies, returning the economy to full employment
• Keynesian economists argue that equilibrium can be achieved below full employment. The key point of disagreement between classical and keynesian economists is the extent to which workers react to unemployment by accepting real wage cuts
• a rise in aggregate demand in the classical model will lead to an increase in the equilibrium price level but no change in equilibrium output
• a rise in aggregate demand in the keynesian model will lead to an inflationary gap without an increase in output
• a rise in aggregate supply in the classical model will lead to an increase in equilibrium output and reduce the price level
• a rise in aggregate supply in the keynesian model will lead to a rise in output and a fall in prices if the economy is near full employment
• the multiplier effect states that each time money is spent, it becomes someone else's income due to a ripple effect. Making it a greater output than the initial injection. This can be a positive or negative effect.
• John Maynard Keynes stated that if there is an increase in investment of £1 national income would increase by more than £1 because of the multiplier effect
• the multiplier model states that the higher the leakages from the circular flow the smaller the increase in national income
• MPC = the change in consumption following a change in income
• MPS = change in savings following a change in income
• consumer confidence, income levels and interest rates all effect the marginal propensity to consume
• the multiplier calculation = 1 / 1 - MPC
• there is a high multiplier value when, the economy has plenty of spare capacity to meet demand, marginal propensity to import and tax is low and when there is a high propensity to consume any extra income
• there is a low multiplier value when, the economy is close to it's capacity limits, propensity to import goods and services is high and when there is a high inflation rate, causing higher interest rates and dampens other components of AD
• the circular flow of income is money that flows between households and firms including injections and withdrawals
• a positive multiplier effect is when an initial increase in an injection (or a

  decrease in a leakage) leads to a greater final increase in real GDP.
• a negative multiplier effect is when an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease in real GDP.