The Circular Flow of Income (& the multiplier)

Typical exam questions

1. Identify three injections into the Circular Flow of Income. [3]
- Capital spending by firms,
- The government expenditure
- Overseas consumers buying UK goods and service,

2. Identify three withdrawals from the Circular Flow of Income. [3]

- Put aside for future spending, i.e. savings
- Paid to the government in taxation
- Spent on foreign-made goods and services

3. In the Circular Flow of Income model, which of the following equations is correct?

A Income = Injections + Withdrawals

B Income + Output = Expenditure
C Income = Output = Expenditure
D Injections = Savings + Taxes

Your answer C [1]

4. Identify and explain how one withdrawal might affect the Circular Flow of Income. [3]
One withdrawal is savings. Households dispose of their post-tax income by spending or saving.
Saving is a withdrawal from the circular flow of income and it has a pivotal role in determining
changes in national income over time.

5. Other than the National Income method, state two other methods of measuring GDP. [2]
The expenditure method and the output method.

6. Explain the difference between GDP and GNP. [2]

GDP measures the value of goods and services produced within a country's borders, by citizens
and non-citizens alike. GNP measures the value of goods and services produced by only a
country's citizens but both domestically and abroad.

7. Explain the concept of the ‘multiplier effect’. [4]

The multiplier effect refers to the idea that when there is an injection of money into an economy (e.g.
from Investment, Government Spending or Exports), then that money flows around the economy a
number of times, so that the total amount spent adds up to more than the size of the original
investment. For example, if an injection of £10m, results in total additional spending of £20m, then the
multiplier is 2 (twice the original injection). The size of the multiplier is affected by the marginal
propensity to consume vs the marginal propensity to withdraw (made up of savings, taxes and
imports).
8. If an injection of £100bn into an economy results in a rise in GDP by £150bn, what is the size of
the multiplier?

A 0.5
B 1.5
C3
D 15

Your answer B [1]

9. Bob earns £1,000 per month and usually spends £900 per month. Calculate Bob’s Average
Propensity to Consume.

A 0.6
B 0.75
C 0.8
D 0.9

Your answer D [1]

10. Referring to information in the previous question; Bob gets a pay rise to £1,200 per month and
his monthly expenditure rises to £1,000. Calculate Bob’s Marginal Propensity to Consume.

A 0.3
B 0.65
C 0.5
D 0.1

Your answer C [1]

11. Identify and explain two factors that might affect households’ ‘average propensity to
consume’. [4]
Taxes: If taxes increase it will have less disposable income. This means less consumer spending and so
decreases average propensity to consume.
Interest Rates: If interest rates decrease there will be incentive to spend more. As a result, it will
increase consumer spending causing it to increase average propensity to consume.

12. With the aid of a diagram, outline the Circular Flow of Income model, and then explain the
effects of injections and withdrawals on an economy. [8]
The Circular Flow of Income model (CFI) shows that money flows around the economy between
households and firms. Households provide land, labour and capital in return for income (rent, wages,
interest and profit – National Income). Households then use that income to buy goods and services
(National Expenditure) which are provided by firms (National Output).
If there is an injection into the CFI (through investment, government spending, or exports), then the
economy will grow and GDP will rise. If there is a withdrawal from the CFI (through saving, taxes, or
imports), then the economy will shrink and GDP will fall.
13. Identify the three missing points in the diagram below. [3]

1? Imports

2? Factors of production

3? Investment

14. Which of the following will y?

A A rise in the marginal propensity to consume

B A rise in the marginal propensity to save
C A rise in the marginal propensity to tax
D A rise in the marginal propensity to import

Your answer A [1]

15. An economy has the following withdrawal rates:
 Marginal propensity to save = 0.2
 Marginal propensity to tax = 0.2
 Marginal propensity to import = 0.1
If the government wants to increase GDP from £100bn to £150bn, how much should it inject into
the economy through increased government spending?

A £10bn
B £25bn
C £50bn
D £100bn

Your answer B [1]