Circular Flow of Income

1. What is the Circular Flow of income and what does it represent?

• The circular flow of income is representative of the economy, it shows the constant cycle of spending, output and income received by households and firms within an economy. It represents the relationship between Households and Consumers in terms of households gaining wages, in exchange firms gain consumers expenditure - The circular flow of income also indicates the withdrawals and injections into an economy.

2. Diagram (Unincluding withdrawals and injections)

• The diagram above illustrates the basic circular flow of income, Households are rewarded for the work input through wages, of that wage the disposable income is spent on goods and services provided by the firm - this results in the money returning to the firm in the form of revenue, and this cycle is repeated.

3. Explain the effect of an increase/decrease in injections.

• An increase of injections into the economy is likely to have a positive multiplier effect. Increasing injections will result in more money in the economy, this would increase the size of the economy and encourage spending on consumer goods. A decrease of injections would have the opposite effect, it would cause consumers to save and result in the local economy improving as less imports are demanded.

4. Explain the effect of an increase/decrease in withdrawals.

• An increase in withdrawals will result in less money flowing within the economy, this could be through an increase in savings. An increase in taxes will result in a decrease in consumer spending, this will lower aggregate demand and result in less money within the circular flow.

5. What is the difference between national output, national income and national expenditure?

• National Output is the value of the goods and services provided to households by firms, this is seen in the diagram as the curved arrow on top - this is the opposite of national expenditure which is the total amount spent on goods and services by a household. National income is the value of incomes received by households in exchange for capital, land and labor.

6. What is the multiplier effect?

• The multiplier effect is the result of a change in economic policy that leads to a knock on effect within the economy. A multiplier effect can be both positive and negative - for example a decrease on income tax will result in an increase in consumer expenditure, this will result in an increase in revenues for firms, this has an beneficial impact on the economy. An example of a negative multiplier effect would be an increase in unemployment if tax's are increased.

7. Explain how an increase in injections leads to a multiplier effect.

• An increase in injections such as investment will result in better living standards for the general population, this is as a result of an increase of money with the circular flow of income that encourages firms to increase productivity as well as efficiency. For example investments to improve capital to encourage an increase in output will allow firms to decrease their average cost per unit and therefore supply it at a lower price into the market, this will encourage consumers to spend more as a result of the decrease in prices - this is returned to the firms in the form of revenues and the effect continues. 

Economic Growth

Causes:

• Economic growth can be caused by technological improvements that lead to an increase in output at a higher quality, for Example the introduction of a new and revised machine that (in comparison to its predecessor) doubles output. Educational improvements that result in a better qualified and more efficient work force will cause economic growth, this would be as a result of their increased range of abilities that allows them to find job and contribute to the economies growth, in addition decreasing the level of unemployment by introducing training programmes would result in further economic growth. Increases in FDI would encourage an improvement in productivity, as well as improvements in capital will result in more efficient and modern facilities that can contribute to countries economic growth. This could also be achieved through increasing government expenditure on sectors that contribute the most to economic growth, if the government were to create free-zones  it would encourage firms to set up within the country, this would decrease unemployment and increase productivity and result in further economic growth.

• Economic Growth could result in increasing inflation, this would be as a result of increased consumer spending. This would have a negative impact on producers and consumers, however producers would benefit from the increase in revenue, this would allow them to further invest in their firm and cause a positive multiplier effect. Producers will end up with increased cost of production that could then be passed on to the consumer - this would mean basic goods and services will take a greater proportion of an individuals disposable income, this would discourage spending, this is the result in the long term. In Addition economic growth would lead increase of the negative externalities associated with economic growth. For example economic growth would result in more air pollution being created as there is greater productivity than before, it would cause further unequal distribution of wealth between classes, an in some casses cause more poverty as a result of the increase in exploitation of workers. Increasing consumption of resources will result in less availability of resources in the long term, this could have massive implications on the economy in the long term as they would no longer be able to sustain the countries consumption without a local market.

• With economic growth comes improved living standards, this is as a result of the increase in real GDP. Consumers generally have more disposable income and are more willing and able to afford more expensive luxury goods, producers will benefit from the increase in revenue as a result of the increase in consumer spending. Economic growth decreases unemployment because of the growing demand for labour from the market, this would have a massive positive multiplier affect on the economy.