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Economics: SL Revision Notes

SL IB Economics

Revision Notes

Home / IB / Economics / SL / Revision Notes / 3. Macroeconomics / 3.1 Measuring Economic Activity / 3.1.1 National Income & The Circular Flow of Income


3.1.1 National Income & The Circular Flow of Income


An Introduction to National Income

  • National income accounting measures the economic activity within a country and provides insights into how a country is performing
  • One of the main methods to determine economic activity is to measure the rate of change of output in an economy
  • The output of an economy is called gross domestic product (GDP)
  • Nominal GDP is the value of all goods/services produced in an economy in a one-year period 

  • The circular flow of income model is used to illustrate national income and the flow of money, resources and goods in an economy

The Circular Flow of Income Model

  • Money can enter or leave the circular flow of income in an economy

  • Injections add money to the circular flow of income and increase its size
    • Increased government spending (G)
    • Increased investment (I)
    • Increased exports (X)
       
  • Leakages (withdrawals) remove money from the circular flow of income and reduce its size
    • Increased savings by households (S)
    • Increased taxation by the government (T)
    • Increased import purchases (M)
       
  • There are high levels of interdependence between households, firms, the government, the financial sector, and the foreign sector (foreign firms and households)
      

~kqgADQP_1-1-4-circular-flow

A diagram that shows the injections and leakages that influence the relative size of the circular flow of income
 

Diagram Analysis

  • Government: Government spending (G) is an injection and taxation (T) is a leakage
  • Financial sector: Investment (I) is an injection and savings (S) is a leakage
  • Foreign sector: Exports (X) is an injection and imports (M) is a leakage
     
  • The relative size of the injections and withdrawals impacts the size of the economy:
    • Injections > withdrawals = economic growth and increase in national income
    • Withdrawals > injections = economic decline and a fall in national income
       
  • Changes to any of the factors that influence government spending, investment, consumption and net exports will increase/decrease the relative size of the circular flow of income
    • E.g. An increase in interest rates will increase savings (withdrawal), and reduce consumption and investment

Exam Tip

Remember to consider the net effect and proportionality of the injections and withdrawals. For example if the size of the government spending is large, it is likely to completely outweigh the combined withdrawals of savings and imports.

Three Approaches to the Calculation of National Income

  • With reference to the circular flow of income model, national income can be calculated using three possible approaches
     
    2-4-1-simple-circular-flow-of-income

Expenditure, income and output can be illustrated in the circular flow of income model
  

  1. The expenditure approach
    • This approach adds up the value of all the expenditures in the economy in a year and includes consumption (C), government spending (G), investment (I) by firms and net exports (X - M)
    • Nominal GDP = C + I + G + (X-M)
       
  2. The income approach
    • This approach adds up the payments (rewards) for the factors of production in a year and includes the wages from labour (W), rent from land (R), interest from capital (I) and profit from entrepreneurship (P)
    • National Income = W + R + I + P
       
  3. The output approach
    • This approach adds up the value of all finished goods/services produced within the economy each year (national output)
        
  • All approaches should provide the same figure
    • One agent's expenditure is another agent's income
    • The value of finished goods ready for sale is equal to the expenditure paid to acquire them

  • The value of GDP is different to the volume of GDP
    • The value is the monetary worth
    • The volume is the physical number

Calculating Nominal GDP Using the Expenditure Approach

  • Nominal GDP can be calculated using the value of the expenditure in an economy
    • GDP = Consumption (C) + Investment (I) + Government spending (G) + Exports (X) - Imports (M)
    • GDP = C + I + G + (X-M)
    • If any of the components of GDP increase, then economic growth is likely to occur

The components

  • Consumption is the total spending on goods/services by consumers (households) in an economy 
  • Investment is the total spending on capital goods by firms 
  • Government spending is the total spending by the government in the economy
    • Includes public sector salaries, payments for the provision of merit and public goods etc.
    • It does not include transfer payments
  • Net exports are the difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad

Worked Example

The table provides national income data for Vietnam in 2019 - presented in US$. Calculate the nominal GDP using the expenditure method [2]


Category


Value in US$ millions

Consumption  11255
Investment  8927
Income tax 59577
Government spending  15697
Imports 4957
Exports 8532

Step 1:  Determine which of the data presented is relevant to the calculation

GDP = C + I + G + (X-M)

So income tax is not relevant (it is a leakage) 


Step 2: Substitute the relevant values into the formula

GDP = C + I + G + (X-M)

GDP = 11255  + 8927 + 15697 + (8532 - 4957)

Nominal GDP = 39,454 $m

 

(Two marks for the correct answer or 1 mark for any correct work in the process)



  • 1. Introduction To Economics
    • 1.1 What Is Economics?
      • 1.1.1 Economics as a Social Science
        • 1.1.2 The Problem of Choice
          • 1.1.3 The Production Possibilities Curve Model (PPC)
            • 1.1.4 Modelling the Economy
            • 1.2 How Do Economists Approach The World?
              • 1.2.1 Economic Methodology
                • 1.2.2 Economic Thought
              • 2. Microeconomics
                • 2.1 Demand
                  • 2.1.1 Demand, Price & Quantity
                    • 2.1.2 Non-Price Determinants of Demand
                    • 2.2 Supply
                      • 2.2.1 Supply, Price & Quantity
                        • 2.2.2 Non-Price Determinants of Supply
                        • 2.3 Competitive Market Equilibrium
                          • 2.3.1 Market Equilibrium & Disequilibrium
                            • 2.3.2 Functions of the Price Mechanism
                              • 2.3.3 Consumer & Producer Surplus
                              • 2.4 Price Elasticity of Demand (PED)
                                • 2.4.1 Definition, Calculation & Determinants of PED
                                  • 2.4.2 The Significance of PED
                                  • 2.5 Income Elasticity of Demand (YED)
                                    • 2.5.1 Definition, Calculation & Illustration of YED
                                    • 2.6 Price Elasticity of Supply (PES)
                                      • 2.6.1 Definition, Calculation & Determinants of PES
                                      • 2.7 Role of Government In Microeconomics
                                        • 2.7.1 Reasons For Government Intervention In Markets
                                          • 2.7.2 Government Intervention: Indirect Taxes & Subsidies
                                            • 2.7.3 Government Intervention: Price Controls, Direct Provision & Regulation
                                            • 2.8 Market Failure: Externalities & Common Pool (Access) Resources
                                              • 2.8.1 Market Failure
                                                • 2.8.2 Negative Externalities
                                                  • 2.8.3 Positive Externalities
                                                    • 2.8.4 Common Pool (Access) Resources
                                                      • 2.8.5 Government Intervention to Address the Market Failure
                                                        • 2.8.6 Other Interventions to Address the Market Failure
                                                        • 2.9 Market Failure: Public Goods
                                                          • 2.9.1 Public Goods
                                                        • 3. Macroeconomics
                                                          • 3.1 Measuring Economic Activity
                                                            • 3.1.1 National Income & The Circular Flow of Income
                                                              • 3.1.2 National Income Terminology & Calculations
                                                                • 3.1.3 The Business Cycle
                                                                  • 3.1.4 Appropriateness of Using GDP/GNI to Measure Well-being
                                                                    • 3.1.5 Alternative Measures of Well-Being
                                                                    • 3.2 Variations in Economic Activity (AD & AS)
                                                                      • 3.2.1 Aggregate Demand (AD)
                                                                        • 3.2.2 Short-Run Aggregate Supply (SRAS)
                                                                          • 3.2.3 Alternative Views of Aggregate Supply (AS)
                                                                            • 3.2.4 Shifts of the Long-Run Aggregate Supply (LRAS)
                                                                              • 3.2.5 Macroeconomic Equilibrium
                                                                              • 3.3 Macroeconomic Objectives
                                                                                • 3.3.1 An Introduction to Macroeconomic Objectives
                                                                                  • 3.3.2 Economic Growth
                                                                                    • 3.3.3 Low Unemployment
                                                                                      • 3.3.4 Low & Stable Rate of Inflation
                                                                                        • 3.3.5 Potential Conflicts Between Macroeconomic Objectives
                                                                                        • 3.4 Inequality & Poverty
                                                                                          • 3.4.1 Measuring Inequality & Poverty
                                                                                            • 3.4.2 Causes of Inequality & Poverty
                                                                                              • 3.4.3 Using Taxation to Reduce Inequality & Poverty
                                                                                                • 3.4.4 Other Policies to Reduce Inequality & Poverty
                                                                                                • 3.5 Demand Management: Monetary Policy
                                                                                                  • 3.5.1 An Overview of Monetary Policy
                                                                                                  • 3.6 Demand Management: Fiscal Policy
                                                                                                    • 3.6.1 An Overview of Fiscal Policy
                                                                                                    • 3.7 Supply-Side Policies
                                                                                                      • 3.7.1 An Overview of Supply-Side Policies
                                                                                                        • 3.7.2 The Effectiveness of Supply-Side Policies
                                                                                                      • 4. The Global Economy
                                                                                                        • 4.1 Benefits of International Trade
                                                                                                          • 4.1.1 The Advantages of Free Trade
                                                                                                          • 4.2 Types of Trade Protection
                                                                                                            • 4.2.1 Tariffs
                                                                                                              • 4.2.2 Quotas
                                                                                                                • 4.2.3 Export Subsidies
                                                                                                                  • 4.2.4 Administrative Barriers
                                                                                                                  • 4.3 Arguments For & Against Trade Protection
                                                                                                                    • 4.3.1 Arguments For & Against Trade Protection
                                                                                                                    • 4.4 Economic Integration
                                                                                                                      • 4.4.1 Understanding Economic Integration
                                                                                                                        • 4.4.2 Types of Trading Blocs
                                                                                                                          • 4.4.3 The World Trade Organisation (WTO)
                                                                                                                          • 4.5 Exchange Rates
                                                                                                                            • 4.5.1 Types of Exchange Rate Systems
                                                                                                                              • 4.5.2 Causes & Consequences of Exchange Rate Fluctuations
                                                                                                                              • 4.6 Balance of Payments
                                                                                                                                • 4.6.1 Components of the Balance of Payments
                                                                                                                                • 4.7 Sustainable Development
                                                                                                                                  • 4.7.1 The Sustainable Development Goals
                                                                                                                                  • 4.8 Measuring Economic Development
                                                                                                                                    • 4.8.1 Single Indicators of Development
                                                                                                                                      • 4.8.2 Composite Indicators of Development
                                                                                                                                        • 4.8.3 Evaluating the Different Approaches
                                                                                                                                        • 4.9 Barriers to Economic Growth & Development
                                                                                                                                          • 4.9.1 Poverty Traps
                                                                                                                                            • 4.9.2 Economic, Political & Social Barriers
                                                                                                                                            • 4.10 Economic Growth & Development Strategies
                                                                                                                                              • 4.10.1 Trade Strategies, Diversification & Social Enterprise
                                                                                                                                                • 4.10.2 Market-Based & Interventionist Policies
                                                                                                                                                  • 4.10.3 Merit Goods & Inward Foreign Direct Investment
                                                                                                                                                    • 4.10.4 Foreign Aid & Development Assistance
                                                                                                                                                      • 4.10.5 Institutional Change
                                                                                                                                                        • 4.10.6 Evaluating Market Orientated Approaches Versus Government Intervention
                                                                                                                                                          • 4.10.7 Progress Towards Sustainable Development Goals

                                                                                                                                                        Author: Steve



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