2.4 National Income

• What is the circular flow of income used for in economics?


  Modeling the economy and understanding growth
• What are the two important conclusions derived from the circular flow of income?

  Economic growth and measuring GDP
• What are the two fundamental economic agents in the simple economy model?

  Households and firms
• What do households provide to firms in the circular flow model?

  Factors of production
• What are the four fundamental factors of production?

  Land, labor, capital, and enterprise
• What do firms do with the factors of production they receive?

  Combine them to make goods and services
• What do households receive in return for providing factors of production?

  Factor incomes
• What is the reward for labor in the circular flow model?

  Wages and salaries
• What is the reward for land in the circular flow model?

  Rent
• What is the reward for entrepreneurship in the circular flow model?

  Profit
• What is the reward for capital in the circular flow model?

  Interest
• What do households do with their factor incomes?

  Spend them on goods and services
• What is the circular flow of income model?

  • A model representing economic activity
  • Shows movement of spending and income
  • Involves households and firms
• What two sectors are ignored in the simple circular flow model?

  Government and international sector
• What are the three leakages from the circular flow of income?

  Savings, taxation, and imports
• What are leakages in the circular flow of income?

  Ways income exits the economy
• What are injections in the circular flow of income?

  Ways money enters the economy
• What are the three types of injections into the circular flow?

  Investment, government spending, and exports
• What is the technical definition of investment in the circular flow model?

  Firms spending on capital goods
• What does government spending refer to in the circular flow model?

  Expenditure by the government on goods and services
• What are net exports in the circular flow model?

  Exports minus imports
• What is macroeconomic equilibrium in the context of injections and leakages?

  When injections equal leakages
• How can we determine if economic growth is rising?

  If injections are greater than leakages
• How can we determine if economic growth is decreasing?

  If leakages are greater than injections
• What is GDP a measure of?

  Economic growth
• What is the output method of calculating GDP?

  Final value of all goods and services produced
• What is the income method of calculating GDP?

  Adding up all factor incomes earned
• What is the expenditure method of calculating GDP?

  Total expenditure on goods and services
• What does the equation for aggregate demand represent?

  Consumer expenditure plus investment plus government spending plus net exports
• Why are the output, income, and expenditure methods equal to each other?

  They measure the same circular flow of income
• What happens during a transaction in the economy?

  Spending equals output equals income
• How does spending on a cricket bat illustrate the circular flow of income?

  Spending equals the value of the bat, which is income
• What are the key components of the circular flow of income model?

  • Households provide factors of production
  • Firms produce goods and services
  • Households receive factor incomes
  • Expenditure on goods and services
  • Injections and leakages
• What are the implications of the circular flow of income for economic growth?

  • Injections greater than leakages indicate growth
  • Leakages greater than injections indicate decline
  • Equilibrium occurs when injections equal leakages