Edexcel Economics (A) A-level Theme 2: The UK Economy - Performance and Policies 2.4 National Income

Transcription

1 Edexcel Ecnmics (A) A-level Theme 2: The UK Ecnmy - Perfrmance and Plicies 2.4 Natinal Incme Summary Ntes

2 2.4.1 Natinal incme The circular flw f incme Firms and husehlds interact and exchange resurces in an ecnmy. Husehlds supply firms with the factrs f prductin, such as labur, land, capital and enterprise, and in return, they receive wages, rent, dividends and prfit. Firms supply gds and services t husehlds. Cnsumers pay firms fr these. This spending and incme circulates arund the ecnmy in the circular flw f incme, which is represented in the diagram abve. Therefre, natinal incme= natinal utput=natinal expenditure. Saving incme remves it frm the circular flw. This is a withdrawal f incme. Investing mney int the ecnmy is an injectin. Taxes are als a withdrawal f incme, whilst gvernment spending n public and merit gds, and welfare payments, are injectins int the ecnmy. Internatinal trade is als included in the circular flw f incme. Exprts are an injectin int the ecnmy, since gds and services are sld t freign cuntries and revenue in earned frm the sale. Imprts are a withdrawal frm the ecnmy, since mney leaves the cuntry when gds and services are bught frm abrad. The ecnmy reaches a state f equilibrium when the rate f withdrawals = the rate f injectins.

3 The full circular flw f incme can be derived frm this: The distinctin between incme and wealth: Incme is a flw f mney that ges t the factrs f prductin. Fr example, wages, welfare payments, prfits, dividends, rents and interest are frms f incme. Wealth is a stck f assets, such as savings, shares, prperty, bnds and pensin schemes.

4 2.4.2 Injectins and withdrawals The impact f injectins and withdrawals frm the circular flw f incme An injectin int the circular flw f incme is mney which enters the ecnmy. This is in the frm f gvernment spending, investment and exprts. A withdrawal frm the circular flw f incme is mney which leaves the ecnmy. This can be frm taxes, saving and imprts. The ecnmy reaches a state f equilibrium when the rate f withdrawals = the rate f injectins. If there are net injectins int the ecnmy, there will be an expansin f natinal utput. If there are net withdrawals frm the ecnmy, there will be a cntractin f prductin, s utput decreases.

5 2.4.3 Equilibrium levels f real natinal utput Equilibrium real natinal utput The ecnmy reaches a state f equilibrium when the rate f withdrawals = the rate f injectins. This is equivalent t the pint where AD = AS. The effects f shifts in AD and AS n the price level and real natinal utput At a price abve equilibrium, there will be excess supply. At a price belw equilibrium, there will be excess aggregate demand, in the shrt run. Shift in AS:

6 If the ecnmy becmes mre prductive, r if there is an increase in efficiency, supply will shift t the right. This lwers the average price level (Pe t P1) and increases natinal utput (Ye t Y1). The ecnmy is n lnger prducing at lng run equilibrium, as they prducing beynd the LRAS. If AS shifts inwards, price increases and natinal utput decreases. Shift in AD: If firms have less cnfidence r there is a recessin, AD might shift inwards. This causes the price level t fall frm Pe t P1, and natinal utput t fall frm Ye t Y1. If AD increases, the price level and level f natinal utput bth increase.

7 2.4.4 The multiplier The multiplier rati This is the rati f the rise natinal incme t the initial rise in AD. In ther wrds, it is the number f times a rise in natinal incme is larger than the rise in the initial injectin f AD, which led t the rise in natinal incme. The multiplier prcess The multiplier effect ccurs when there is new demand in an ecnmy. This leads t an injectin f mre incme int the circular flw f incme, which leads t ecnmic grwth. This leads t mre jbs being created, higher average incmes, mre spending, and eventually, mre incme is created. The multiplier effect refers t hw an initial increase in AD leads t an even bigger increase in natinal incme. It ccurs since ne persn s spending is anther persn s incme. Effects f marginal prpensities n the multiplier Marginal prpensity t cnsume (MPC) A cnsumer s marginal prpensity t cnsume is the prprtin f each additinal pund f husehld incme that is spent. The higher the MPC, the bigger the size f the multiplier. The gvernment culd influence the MPC by changing the rate f direct tax. If cnsumers have mre dispsable incme due t lwer incme tax rates, their prpensity t cnsume might increase. Marginal prpensity t save (MPS) A cnsumer s marginal prpensity t save plus the marginal prpensity t cnsume is equal t 1. If cnsumers save mre than they spend, the size f the multiplier will be small. Marginal prpensity t tax (MPT)

8 This is defined as the prprtin f each pund taxed by the gvernment. The higher the rate f tax, the less dispsable incme each cnsumer has, and the smaller the size f the multiplier. Marginal prpensity t imprt (MPM) If cnsumers spend incme n imprts rather than dmestic gds and services, incme is withdrawn frm the circular flw f incme. This reduces the size f the multiplier. Calculating the multiplier One frmula that can be used t calculate the multiplier is 1/(1-MPC). Example: If cnsumers spend 0.6 f every 1 they earn, they save 0/4. Therefre, the multiplier will be: 1/(1-0.6) = 1/0.4 = 2.5. This means that every 1 f incme generates 2.50 f new incme. An pen ecnmy has three areas f withdrawals: taxes, imprts and savings. The marginal prpensity t withdraw is calculated by MPW = MPS + MPT + MPM This gives anther frmula fr calculating the multiplier: 1/MPW The significance f the multiplier t shifts in AD If an ecnmy has a lt f spare capacity, extra utput can be prduced quickly and at little extra cst. This makes AS elastic and it means the size f the multiplier will be larger. A small increase in AD will lead t a large increase in natinal incme. This is perhaps best shwn n the Keynesian curve. The vertical sectin is perfectly inelastic, with n spare capacity, whilst the hrizntal sectin is perfectly elastic, with lts f spare capacity.

9 If AS is inelastic, the multiplier effect is likely t be smaller than its ptential. This is because if AD increases, prices will increase. The increase in utput will nt be as significant. It is als pssible t have a reverse multiplier. This means that a withdrawal f incme frm the circular flw f incme culd lead t an even larger decrease in incme fr the ecnmy. This culd decrease ecnmic grwth and ptentially lead t a decline in the ecnmy.