How National Income is Determined

How National Income is Determined

Question 1/2 - Describe how national income is determined. Include a description of equilibrium, using income and expenditure, and leakages and injections.

How much wages people get and their spending determine national income. The

above circular flow shows that although wages are being spent in the households the

money still works its way back to the firms.

The leakages in the circular flow are the money is the money that households are

paying back into firms and services from wages they are paid. The savings are the

money people save in their banks, taxes are the tax that people pay in their wages

weekly, monthly or fortnightly and imports are items that the people have bought

from companies.

The injections in the circular flow is the money that has been put into firms and

services. the investments are the money firms and the government have invested into

companies, the government spending is the money the government spend on firms

and services and exports are the money the firms and companies spend buying goods

to sell.

The money keeps on going round and round.

The equilibrium is when the leakages and injections are the same.

i.e. if the leakages = £23500, the injections will = £23500. The

equilibrium is where they meet.

Question 3 - Explain the concept of the multiplier with regard to

National Income using a worded example.

According to the Keynes a rise in the injection to the circular flow will cause the

incomes and employment to increase by more than the increase in investment.

The equilibrium at start -:

If there is an increase in investments of £20m. The effect of this will be to raise

incomes by the same, the people who receive this increase will spend some and save

some. If 3 quarters are spend and 1 quarter is saved. this would mean £15m is

and is turned into income for other people, which leaves £5m being saved. Incomes

have increased by the original £20m, but also by the £15m due to people spending

extra. The people who receive the extra income will spend 3 quarters and save 1

quarter and so it goes round and round. Incomes increase a little as follows: -

£20m + (3/4 x £20m) + (3/4 x 3/4 x £20m) + (3/4 x 3/4 x 3/4 x£20m)etc. . . . . . .

The multiplier is denoted as k -: k = 1 = 4 1 - 3/4

Total extra income -: 4 x £20m = £80m

Total extra savings -: £20m

The new equilibrium is -:

Question 4 - What is meant by the term's aggregate demand and aggregate supply?