Prep - The Circular Flow of

Income
Read and take notes on pages 160-166 then answer the following questions

1. Missing words
For an economy to be in _________________________, injections must be to withdrawals.

Injections into the circular flow are made up of investment, ____________________ and

__________________, while withdrawals comprise of savings, ________________________ and

____________________. If injections do not equal withdrawals, then the economy is said to be in

disequilibrium. If withdrawals are greater than injections, the economy will suffer declining incomes, output

and ____________________. Eventually, lower incomes will reduce the levels of taxation and saving, causing

leakages to shrink until they equal injections. If injections are greater than withdrawals, the economy will be

expanding (economic growth). When the economy is growing (injections are ___________________ than

withdrawals), households and firms will pay ________________ tax, and are also likely to save more.

Households are also likely to buy more goods from ___________________. This will cause the value of

leakages to increase, up to the point where they are equal to injections. At this point the economy has

returned to equilibrium.

MISSING WORDS: EXPENDITURE, IMPORTS , MORE , GOVT SPENDING, EQUAL , GREATER , EXPORTS , OVERSEAS , EQUILIBRIUM ,
TAXATION

2. Organise the following (a-h) under the 4 headings.

Households Firms Government Banks

a) Receive tax from firms and households b) Pay interest on deposits held c) Hold savings
d) Hire the factors of production e) Purchase output from firms f) Pay income tax
g) pay corporation tax h) Receive income for factors of production
3. Draw a circular flow diagram

4. Multiple Choice

Select the alternative that most fully and correctly answers the following questions

1) Government taxation has the same effect on the circular flow of income as
a. investment
b. saving
c. consumption
d. depreciation

2) Foreign capital inflow into the UK has the same effect on the circular flow as
a. government taxation
b. import spending
c. domestic savings
d. domestic investment
3) The circular flow of income is said to be in equilibrium when
a. planned savings equal planned investment
b. planned savings equal planned consumption
c. planned savings equal actual income
d. (planned savings equal real interest rates

4) If planned investment is greater than planned savings then the

a. level of income will tend to rise
b. level of income will tend to fall
c. level of income will move into surplus
d. level of income will remain unchanged

5) Which of the following is a leakage from the circular flow?

a. factor payments
b. government spending
c. export receipts
d. taxation

6) The UK will experience a rise in economic activity when

a. investment and government spending exceed domestic consumption
b. savings and investment are less than net exports
c. saving and taxation are less than investment and government spending
d. net domestic consumption is greater than factor payments to households

7) In the circular flow model households receive income in the form of

a. salaries, dividends, capital gains and rent
b. wages, salaries and supplementary payments
c. wages, salaries, dividends and rentals
d. wages, rent, interest and profit

8) Investment is defined as
a. the purchase of capital plus any changes in inventories
b. the purchase of government bonds or debentures
c. the accumulation of undistributed profits plus inventories
d. the accumulation of reserve funds held in bank accounts
9) Which of the following would assist the government in maintaining equilibrium in the level of income?
a. when saving exceeds investment then the government should tax more than it spends
b. when saving exceeds investment then the government should spend more than it taxes
c. when saving exceeds consumption the government should tax more and spend less
d. when saving and investment both exceed government spending then tax cuts are appropriate

10) Which of the following cannot be regarded as an injection in the circular flow of income?
a. government spending
b. export receipts
c. domestic saving
d. investment spending

11) Which of the following represents equilibrium in the circular flow in an open economy?
a. S+T+X=I+G+M
b. S+G+M=I+T+X
c. I+T+X=S+G+M
d. I+G+X=S+T+M
e. I+G=S+T