EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Economic Growth

THEME 2
Economic growth Purchasing Power Parity (PPP)
Economic growth: increase in the potential output of an economy or in Purchasing power parity (PPP) is used when assessing relative living
the real value of goods & services produced, measured by the % standards between countries. Real GDP needs to be converted into the same
change in real GDP. currency for comparison, but the market exchange rate does not reflect
Gross domestic product (GDP): measures the value of real output of differences in the cost of living/purchasing power of income in the countries.
the economy over a period of time; a rise in GDP indicates economic PPP is calculated by comparing the price of a basket of comparable goods
growth. and services in different countries. PPP measures the total amount of goods
Nominal GDP: the monetary value of all goods and services produced and services that a single unit of a country’s currency can buy in another
in the economy (GDP at current prices). country.
Real GDP: the nominal value of GDP adjusted for inflation (GDP at
constant prices). Using a PPF diagram to show economic growth
Real GDP per capita: national income per person often used a proxy
measure for the standard of living.
Value v volume: the value of goods and services shows what they are
worth; the volume shows the number that are produced.

Other national income measures

GDP: value of national output produced in an economy
Gross National Product (GNP): GDP + net property income from abroad
Gross National Income (GNI): similar to GNP = final value of income
flowing to a country's owned factors of production in a given year
GNI = Gross Domestic Product + net income from abroad of
compensation of employees and property income.
GNI could be higher than GDP if there is:
• income from worker remittances,
• income from interest on bonds and savings held overseas
• income from dividends on profits from overseas investment
• overseas aid transfers (inflows) for poorer countries.
(NB: GNI can be lower than GDP if these flows are reversed)
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance
THEME 2 Standard of living Economic growth and Standard of Living National wellbeing and subjective happiness
Standard of living – a measure of economic welfare and wellbeing. While more Subjective happiness refers to ‘self-reported’ levels of happiness
income typically increases the standard of living the relationship is not exact. with one’s life, usually determined using questionnaires
which consider emotions, rather than asking about material well-
Other factors that affect the standard of living include: access to good healthcare, being.
access to good education and skills, quality of housing, quality of job, access to Factors that tend to affect your happiness include: your personality
good quality public services, quality of environment, a sense of fairness, life and genetics, social influences (e.g. friends), income and wealth (to
satisfaction, personal freedom, political freedom etc. a smaller degree than you might expect), health, and leisure time.
Limitations of using GDP to compare living standards Easterlin Paradox: life satisfa; beyond ction does rise with average
incomes but only up to a pointthat the marginal gain in happiness
Economists use real GDP per capita as a proxy/rough guide for the standard of declines.
living
Real – takes inflation into account; per capita – takes population change into Human Development Index (HDI)
account The HDI is calculated by the United Nations as an indicator of
BUT real GDP per capita is still an average and it does not effectively take into economic development and broader measure of the standard of
account many other factors that influence the standard of living living. It looks at:
• the distribution of income • Health – life expectancy at birth;
• the value of unpaid work (housework, child care, DIY, voluntary work) • Education – mean years of schooling of adults and expected
• environmental degradation and depletion/impact on natural capital years of schooling of children;
• negative externalities of consumption of goods that are bad for us (eg • Living standards – GNI per capita.
tobacco, alcohol) and production (eg pollution, congestion) Advantages of using HDI – broader measure; better measure of
• shadow market activity/unofficial work development; better measure of standard of living and wellbeing
• impact on standard of living of changing working hours/conditions/leisure Disadvantages – still does not take all aspects of wellbeing into
time/quality of jobs account; weighting of the three categories is arbitrary
• the changing quality of goods/services over time
Other measures of living standards
• impact of technological improvements on the standard of living
Other measures include the Happy Planet Index, the Social Progress
GDP data is also not necessarily accurate - difficulties collecting data and
Index, the ONS Well-being dashboard, OECD Better Life Index etc.
making accurate calculations ; GDP measures looks backwards; GDP data often
All of these include more factors that affect economic welfare, but
needs to be revised; some countries are likely to be have more accurate data
become more complex; real GDP per capita often 'tracks’ these
than others.
broader measures with varying degrees of accuracy.
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Inflation (1)
THEME 2 Inflation Limitations of the CPI inflation measure
Inflation – a sustained increase in the general price level. • CPI inflation is only calculated for an 'average' family
Deflation – a sustained decrease in the general price level. • It does not consider quality of goods/services
• Needs regular updating to reflect changes in patterns of spending
Disinflation – a reduction in the rate of inflation (the inflation rate falls but
• International comparisons may not be accurate if other countries do not calculate
the price level is still rising, but at a slower rate). inflation in the same way
Cost-of-living - a measure of changes in the average cost for a household of Costs of inflation
buying a basket of different goods and services.
Inflation target – a target set by the government which the central bank Shoe leather costs: costs of shopping around when prices change rapidly
should aim to achieve eg in UK it is CPI inflation = 2% +/- 1% point Menu costs: costs of redoing menus, parking changes, price labels & lists
Fall in real incomes: if wages do not keep pace with prices, real incomes
Calculating inflation using the Consumer Price Index (CPI) fall
The 'headline' rate of inflation is the annual % change in the CPI. The Uncertainty: consumers and businesses may reduce their spending
CPI tracks changes in the prices of a basket of goods and services causing unemployment and weaker growth
purchased by an average household. It is expressed as an index number. Redistributional effects: savers get a lower real rate of return, those on
The formula for calculating CPI inflation is: fixed incomes lose out, workers in the gig economy may not be able to
CPI Inflation Rate = [(Current CPI - Previous CPI) / Previous CPI] × 100 negotiate real wage increases; fiscal drag increase tax paid if thresholds
Basket of goods and services = things a typical household buys; updated are frozen
each year to keep it relevant. Price survey – prices of the goods and Loss of international competitiveness: weaker current account on the
services in the basket are monitored each month. The price of each Balance of Payments as exports become relatively more expensive and
representative good/service in the basket is weighted according to the imports relatively cheaper
proportion of income a typical household spends on it Increase in inflation expectations – people will aim for bigger pay rises if
they expect higher inflation, which can add to business costs and prices
Other measures of inflation
Danger of wage-price spiral – if workers demand big pay rises
CPIH = similar to CPI but also monitors owner occupier housing costs (OOH), in its
basket. These are the costs associated with owning, maintaining and living in one's own Benefits of a low rate of inflation
home. • A low but steady rate implies aggregate demand is running ahead of aggregate
RPI – Retail Price Index - the basket of goods/services includes some items not in the supply, incentivising business investment and growth
CPI, such as council tax & mortgage interest payments; it is often used to calculate • Reduces the real value of debt
increases in welfare benefits, pensions, index-linked bonds and wage negotiations; in a • Allows negative interest rates
period of rising interest rates it typically gives a higher rate of inflation than the CPI • Helps labour markets work more efficiently without a need to cut nominal wages
'Core' inflation – sustained increase in prices of goods in the basket, excluding goods because real wages can fall
such as energy, food, alcohol and tobacco which can have volatile prices. • Makes malign deflation less likely
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Inflation (2)
THEME 2 Causes of inflation – demand pull Causes of inflation – cost-push
Demand-pull Cost-push inflation is
inflation is inflation inflation caused by
caused by excess AD increases in the costs of
in the economy. production in the economy.

Producers can raise Can cause stagflation –

prices and increase when economy stagnates
their profits as price level rises
AD shifts right
SRAS shifts left/up
causing the
causing the price
price level to
level to rise from PL1
rise from PL1 to
to PL2
PL2

Causes of demand-pull inflation Causes of cost-push inflation

• Lower interest rates • Rapid wage rises/higher labour costs
• Lower income tax • Skill shortages
• Rapid income growth • Increasing input costs (raw material, energy)
• High consumer confidence • Higher commodity prices
• Positive wealth effects • Food price inflation
• Easy credit (cheap and accessible credit) • Indirect tax rises
• Depreciation of the currency • Depreciation of currency (imported inflation)
Causes of inflation - growth of the money supply Anticipated v unanticipated inflation
Monetarists argue that inflation is caused by excessive growth of the Inflation tends to be more damaging when is it unanticipated; the costs of
money supply - 'too much money chasing too few goods’. inflation to economic agents are higher when there is an inflation shock eg
Firms and consumers may spend their excess money, thus raising AD; the a sudden sharp increase in energy or food prices.
demand for labour could rise because it is derived from demand for goods Having an inflation target, as is the case in the UK, can help with
increasing wages and costs of production. ‘inflationary expectations’ and ‘anchor’ inflation to the 2% target.
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Inflation (3)
THEME 2
Causes of demand-side deflation – fall in AD Causes of supply-side deflation – increase in AS
Deflation caused by Deflation caused by an
fall in AD ie inflation increase in short run
caused by a lack aggregate supply ie
of AD in the deflation caused by
economy. decreases in the costs of
Producers have to production in the economy;
reduce prices and
their profits fall SRAS shifts right causing
AD shifts left causing the price level to fall from
the price level to PL1 to PL2.
fall from PL1 to PL2; LRAS could also shift
larger negative right.
output gap

Costs of deflation Causes of 'benign' deflation

• Lower AD causes over supply
• Technological advances
• Lower prices for goods and services cuts cash flow and profits for
• Improvements in productivity
businesses; consumers may delay their spending; businesses may cut
• Falling price of commodity prices
investment
• Falling price of energy prices
• Businesses reduce production; cyclical unemployment rises
• Globalisation/economies of scale
• Rise in real value of debt
• Cheaper/more skilled labour (perhaps from immigration)
• Real interest rates may rise reducing consumption and investment
Causes of 'malign' deflation Benefits of deflation
• Negative demand shock (eg credit crunch in global financial crisis 2008-9) • Falling prices for consumers
• Global recession • Increase in real incomes
• Appreciation of currency causing fall in net exports • Increased spending power for those on fixed incomes
• Falling asset prices (negative wealth effect) • Improved international competitiveness
• Contractionary fiscal and/or monetary policy • Falling asset prices make housing more affordable for first time buyersI
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Employment & Unemployment
THEME 2
Labour market terms Types of unemployment
Working population: the total number of individuals who are of working Regional unemployment: unemployment rate varies across regions.
age, typically considered to be those who are capable of and available for Long term unemployment: people unemployed for over 12 months.
work. It includes both employed and unemployed individuals. Mass unemployment: 1 in 10 of the labour force are unemployed.
Labour force: those who are either employed or actively seeking Youth unemployment: unemployment rate (the proportion of the
employment. It is a subset of the working population and represents the economically active population who are unemployed) for all 16 to 24
pool of people available for and actively engaged in productive work. year-olds .
Economic inactivity: not being engaged in the labour force, includes Discouraged workers: inactive work-seekers who have ceased to seek
pensioners, students, homemakers, discouraged workers and others who work because they believe there are no suitable available jobs.
are neither employed nor actively seeking employment. Hidden unemployment: people who do not work but who are not
Labour force participation rate: workers in the labour force compared to counted in government reports, for example, people who have stopped
the number of people in the working population looking for a job and people who work less than they want to.
Employment rate: the proportion of people of working age who are in Underemployment: where individuals are employed, but their
employment (employees, self-employed, full time & part time employment is insufficient in terms of hours worked, skill utilisation, or
income to fully meet their economic needs or potential.
Unemployment terms
Unemployed: someone of working age, willing and able to work, Gig economy
and actively seeking work, but cannot find a job. The gig economy is a work arrangement where people perform short-term,
Unemployment rate: the percentage of the labour force that are unemployed flexible, and often freelance work, typically through online platforms or
(NB the labour force includes those in work and the unemployed) apps, eg rideshare drivers, virtual assistants, and food delivery workers.
It is linked to zero-hour contracts - employment arrangements where
Key measures of unemployment
workers are hired without a guarantee of work hours.
Labour Force Survey - this survey asks 60-70,000 UK households to self-
classify as being employed, unemployed or economically inactive.
Claimant Count - this counts the total number of recipients of Job Seeker's Technological unemployment
Allowance (JSA) added to those looking for work to claim Universal Credit Technological unemployment: the displacement of human workers by
(UC). machines, automation, and technology, such as AI.
Labour market 'flows' Rapid advances in technology raises concerns about the potential for job
People of working age can be employed, unemployed or economically loss, economic inequality, and the need for retraining and upskilling workers
inactive; over time they may 'flow' in and out and between these categories. to adapt to evolving job markets.
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Employment and Unemployment
THEME 2 Causes of unemployment
Causes of unemployment
Frictional unemployment: short-term unemployment Real wage
caused by people moving between jobs, moving to a new location, or unemployment: caused by wages
re-entering the workforce after a break. being too high relative to the
productivity of workers; minimum
Cyclical unemployment: the wages and trade union activity can
unemployment rate push the wage above its market
rises during an economic equilibrium
downturn; it is caused by Current wage is above market-
fluctuations in the business clearing wage W1, causing an
cycle. Sometimes excess supply of labour = real
called demand- wage unemployment
deficient unemployment. AD Full employment
shifts left from AD1 to AD2;
• An absence of cyclical unemployment (the output gap is closed)
new equilibrium Y2 is below
• Number of job vacancies = number of people actively seeking work
full employment income There will always be some unemployment – frictional as people move between jobs
Yfe; some unemployed
resources at Y2 Costs of unemployment
Economic costs - loss of output foregone, fall in real incomes, lower
Structural unemployment: caused by changes in the economy, like standard of living, lower tax revenue, higher welfare costs, larger budget
the decline of certain industries or the rise of automation. It happens deficit, loss of workers to other countries (emigration) etc.
when there's a mismatch between the skills & location of workers and Social costs - increase in poverty and welfare dependency, increase in
the needs of employers. A lack of geographical and occupational physical and mental health increasing healthcare costs, link between
mobility of labour contributes. persistent unemployment and social problems (eg vandalism, low level
crime, shoplifting etc.)
Seasonal unemployment: seasonal workers, such as construction workers,
retail assistants, might be without paid jobs due to the time of year when Benefits of some unemployment
there is less need for their work • Reduced risk of inflation – lower wage demands & price discounts
• Pool of unemployed available for growing businesses
• Increase in self-employment start-ups, more entrepreneurs/innovation
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Measures of Economic Performance – Balance of Payments
THEME 2 Balance of Payments terms Running a current account deficit
Balance of Payments: a record of all the flows of money between the • Suggests a lack of international competitiveness/supply-side weakness
residents of one country and the rest of the world • Withdrawal from the circular flow (X<M) reducing AD, slows growth
Import: an overseas produced good/service purchased by UK citizens • Loss of jobs in home-based industries (regional & structural
resulting in an outflow of income from the UK unemployment)
Export: a UK produced good/service sold overseas resulting in an inflow • May cause a depreciation of the currency & some inflationary pressure
of income into the UK • Foreigners may own more UK assets
Current account on the balance of payments: the section of the balance • More imports can add to the standard of living
of payments that records international trade in goods, services, primary • Imports of capital goods can help boost development
income & secondary income Running a current account surplus -For a surplus, the outcomes of a
Balance of trade in goods and services: the value of exports of goods & current account deficit can be reversed.
services minus the value of imports of goods and services. If this is Causes of a current account deficit
positive, there is a trade surplus, if it is negative there is a trade deficit Cyclical causes Structural causes
• Overvalued exchange rate • Under-investment
Current account on the balance of payments • Boom in domestic demand • Relatively low productivity
• Recession in key export • Persistently high relative
The current account records the exports and imports (inflows and industries inflation
outflows) for these categories: • Slump in global prices of exports • Inadequate R&D, innovation
Trade in goods – oil, energy, raw materials, food, manufactures, semi- • Increased demand for imported • Emergence of low-cost
manufactures, components, capital goods etc. technology competition (emerging markets)
Trade in services – finance, insurance, business services, consulting, • Increase in global • Increase in global
travel/tourism, telecommunication and information etc. energy/commodity prices (for energy/commodity prices (for
Primary income (net investment income) – the inflow of interest, profits net importers) net exporter)
and dividends on UK assets held abroad, less the outflow of interest,
Global interconnectedness through international trade
profits and dividends of foreign-owned assets in the UK.
Secondary income – net current transfers between countries such as • Most countries trade with China and the USA, the two biggest global
foreign aid, gifts, payments to and from EU (due as part of the TCA). economies, and their nearest neighbours the most
Current account balance: the value of exports less the value of imports • Countries connect through trading blocs, such as EU, USMCA, CPTPP
for goods, services, primary and secondary income. • The WTO monitors and promotes tariff-free international trade
• Globalisation has made international supply chains more integrated
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Aggregate Demand – Consumption (C) and Savings (S)
THEME 2 Characteristics of AD Benefits and costs of rising consumption
• Rising AD • Inflation pressure
AD = C + I + G + X – M • Faster short run economic growth • Current account deficit (more
Consumption C: consumer spending on real output; spending on non-
• Less spare capacity imports sucked in)
durables, durables & services; the largest component of AD, usually about
• Falling unemployment • Unbalanced growth
60%
• Gives businesses confidence to • More household debt
Capital Investment I: spending on capital goods; spending on plant,
invest • Could be bad for environment
equipment etc. That help produce more consumer goods in future;
investment demand comes from both private and public sector Saving
Government consumption G: spending by the government on its current Saving (S) is NOT a component of AD, but disposable income that is not spent
day-to-day provision of public services such as healthcare, education, is saved.
defence and transport. Does not include transfer payments (pensions and Savings ratio = Total household savings
welfare benefits) Total household disposable income
Net trade (export demand X - import demand M): exports X are an inflow
of demand from citizens abroad (inflow); imports M refers to domestic Importance of saving for an economy
demand for foreign-produced goods (outflow). • Savings flow into financial markets and businesses can access these funds
to invest
Factors influencing Consumption (C) • Savings provide households with a cushion of financial stability and funds
Income: especially real disposable income; typically more income means for the government when it needs to borrow.
more consumer spending. Paradox of Thrift
Wealth effect: an increase in the value of assets (property, shares etc.) The Keynesian paradox of thrift is an economic theory which states that an
encourages more consumer spending through a positive wealth effect. increase in saving can lead to a decrease in economic activity and, ironically, a
Consumer confidence: high confidence leads to more consumer spending. decrease in overall saving.
Job security: low unemployment can make people less worried they may Related concepts
lose their job and so they spend more.
Interest rates: affect the cost of borrowing; spending on big ticket items Average propensity to consumer (APC)= C/Y
such as houses, cars and white goods are likely to rise when interest rates Marginal propensity to consume (MPC) = change in C/change in Y
fall. Average propensity to save (APS) = S/Y
Demography: a growing population (e.g. immigration) spending more Marginal propensity to save (MPS) = change in S/change in Y
(And vice versa for factors causing a fall in consumption). where Y = national income, C = consumption, S = saving
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Aggregate Demand – Investment (I)
THEME 2 Investment Factors influencing investment
Investment: addition to capital stock of the economy e.g. factories,
• Interest rate: lower interest rate reduces the cost of borrowing and
machines, offices, equipment, stocks of materials used to produce other
boosts the attractiveness of investing relative to retaining profit;
goods.
investment will increase.
Depreciation (capital consumption): value of the capital stock that falls in
• Availability of finance: if a firm is borrowing funds to invest, it has to
value over time as it wears out or is used up.
access them from financial institutions; if the firm has some of its own
Gross investment: investment before depreciation.
funds, it will be easier to borrow.
Net investment: gross investment – depreciation.
• Demand for the final product: if the demand for a firm's output
NB Capital investment is not the same as financial investment
increases, a firm has a greater incentive to expand to meet the
Private sector investment: investment undertaken by businesses in the
demand, driven by potential for more profit.
private sector.
• Business confidence: if business are confident about their future sales
Public sector investment: investment by the government often in
they are more likely to invest.
infrastructure (transport, telecommunications, energy networks, new
• Corporate taxes: if taxes on companies eg corporation tax or business
schools, new hospitals).
rates, fall, there is more retained profit to use for investment.
Foreign direct investment (FDI): capital investment made by a company
• Business regulation: a reduction in red tape and bureaucracy for
based in one country in another country e.g. Nissan in Sunderland.
businesses can incentivise more investment.
Why do firms invest? • Technological change: businesses will invest in new
To expand their business and increase their output capacity technologies/innovations to ensure they do not lag behind their
To reduce average costs of production due to economies of scale competitors.
To increase efficiency and productivity through innovation and technological (And vice versa for factors causing a fall in investment)
progress
To meet an increase in market demand and increase market share How investment influences the macroeconomy
To expand a firm's product range • Creates extra demand in investment goods industries
To replace depreciated capital • Injects money into the circular flow of income (multiplier effect)
To increase competitiveness at home and abroad • Boosts both short run and long run economic growth
Impact of investment on AD & AS • New capital boosts productivity and increases the capacity to supply
Investment adds to aggregate demand AD causing short run growth, lower • Improves a country's competitiveness, improving the trade balance
unemployment • Improves the economy's infrastructure to make it more efficient
Successful investment also adds to the economy's capacity, long run • Can help create new jobs (though some may be lost to automation/AI)
aggregate supply LRAS; long run non-inflationary growth • Can help reduce inflation pressure
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: Aggregate Demand – Government Consumption (G) and net trade (X-M)
THEME 2 Government consumption (G) Government spending and the trade cycle
Government consumption: the day-to-day running costs of government e.g. In an economic downturn/recession, government spending on welfare
wages to public sector workers, energy & rent bills for government offices, benefits and support for businesses increases – this is cyclical government
schools and hospitals etc..; also known as current spending by the spending; the opposite occurs in a growth phase. The government can also
government (NB: Public sector capital spending belongs in Investment I) choose to make discretionary changes to its spending, unrelated to the
It does not include transfer payments (e.g. government spending on welfare economic cycle, e.g. in the Annual Budget.
benefits or pensions – spending on these is not new income but a transfer of Net trade (X-M)
income from taxpayers to other groups) Net trade (X-M): net export demand is the value of exports less the value of
Central government: government run at Westminster imports.
Local government: local councils and county councils, city mayors Trade surplus: net export demand is positive and adds to AD.
Trade deficit: net export demand is negative and reduces AD.
Role of government spending
Trade balance equilibrium: value of exports X equals the value of
Changing government spending is a part of FISCAL policy imports M, net export demand is neutral and AD does not change.
• Can be used to change the level of AD (with fiscal multiplier) Factors influencing net trade
• Can be used to provide public and merit goods • Real income: if incomes are increasing at home, this can suck in
• Can be used to correct market failures, e.g. positive consumption imports reducing X-M; if incomes abroad are increasing, this may
externalities increase exports, increasing X-M.
• Can be used to influence economic regions., e.g. 'levelling up' • Exchange rate: a depreciation makes imports more expensive and
• Can be used to achieve greater equity in society by providing public exports cheaper, which would increase X-M (unless there is a low
services, including universal access to healthcare and education response ie PED for exports or imports is inelastic).
Decisions about how much the government spends in the economy are often • State of global economy: strong global growth may increase demand
dependent on the government's economic and political goals for exports, increasing X-M.
Fiscal policy terms • Degree of protectionism: if other countries are cutting their tariffs and
Budget deficit: government spending exceeds tax revenue G>T; government non-tariff barriers to trade, X-M may rise.
borrows to fund its spending. • Non-price competitiveness: if a country improves its non-price
Budget surplus: government spending is less than tax revenue ie competitiveness (quality, design, speed of delivery, after-sales service)
G<T; government can pay back some of its debt. this could increase X-M.
Balanced budget: government spending equals tax revenue G=T. • Price competitiveness: if a country improves this so its product are
Fiscal multiplier: estimates the final change in real national income (GDP) better value for money, then X-M should increase.
that results from an initial change in government spending plans. (And vice versa for factors causing a fall in net export demand)
EDEXCEL ECONOMICS (A) KNOWLEDGE ORGANISER: National Income
THEME 2 Circular flow of income Explaining the circular flow model
National income: the monetary value of the flow of output produced in an Households earn income by selling their factors of production to firms and
economy over a period time. use it to purchase goods and services produced by the firms, which use up
Households: own the productive resources of the nation, which they these resources.
exchange for rent, wages, interest and profit; they use the income earnt to Financial sector: not all income is spent; some is saved; the financial sector
buy goods and services. lends income saved to businesses to invest
Firms: hire the resources as inputs to use them to produce output; they sell Government sector: some income is taken out of the flow as tax, but the
the goods and services produced to households. government also spends which injects income into the flow
National income can be measured as any point as income flows round the Foreign sector: some income flows out to other countries when imports are
economy so national income = national expenditure = national output purchased; exports add to the flow of income because income comes in
Circular flow model from outside the economy
Injections and withdrawals
Injections add money to the circular flow of income, which can lead to
economic growth; they are investment I, government consumption G and
exports X.
Withdrawals remove money from the circular flow of income, which can
lead to economic contraction; they are savings S, taxation T and imports M.
National income equilibrium: planned injections = planned withdrawals
If injections exceed withdrawals, national income rises (economic growth)
If withdrawals exceed injections, national income falls (economic
contraction).
Wealth and income
Wealth is a stock concept – it is the value of assets held; assets includes
income saved, vales of shares & property owned, money held in pension
funds.
Income is a flow of money going to factors of production – it includes wages
& salaries, rent, profits, people receiving benefits, interest paid.
Income and wealth are NOT the same, but are related; people with higher
incomes can build up their wealth; wealth can generate an extra source of
income. Wealth is more unevenly distributed than income.