The circular flow of income: in an economy, households and firms interact, exchanging resources. Households supply factors of production such as labour, and firms pay wages for them. Firms supply goods and services to households, who pay for them.
Income is a flow of money. Wealth is a stock of assets.
2.4.2 Injections and Withdrawals
Income = output = expenditure.
Injections are forms of spending that enters the circular flow of income.
Injections include investment, government spending or exports.
Withdrawals are leakages of spending from the circular flow.
Withdrawals include imports, taxation and savings.
When the rate of withdrawals equals the rate of injections, the economy reaches equilibrium.
When the rate of injections is greater than the rate of withdrawals in an economy, there is an expansion of aggregate demand and real GDP, and vice versa (contraction).
2.4.3 Equilibrium Levels of Real National Output
The multiplier is the ratio between an initial change in aggregate demand and the change in national income.
An initial change in expenditure (aggregate demand) leads to a larger impact on local or national income.
For example, if the government spends on roadworks, new jobs are created and incomes increase and this leads to larger changes in consumer spending, creating more jobs and more spending.
The marginal propensity to consume (MPC) is the proportion of an increase in income that is spent. Consumers on lower incomes usually have a higher MPC, closer to one.
k = change in national income/ change in spending.
k = 1/ 1- MPC = 1/ MPS.
MPS = 1 – MPC. It is any increase in income that is not spent.
The size of the MPC determines the size of the multiplier effect because it shows how effective government spending will be in boosting consumer spending, confidence and the inflation rate.
MPW=MPS+MPT+MPM (withdrawals from the economy are saving, taxes and imports).