0G] Marne by Teachers Explain how economists model how an increase government expenditure can lead to a greater increase in national income. Ans. National income is the total amount of wealth that accrues to the permanent residents of a country as a result of the production of goods and services within a country during the course of a year. It is important to measure national income because it shows whether the standard of living in a country is rising or falling and it ccan be used as a means of comparison between other countries. It is also useful to ‘measure income against past income in the same country to see whether the economy is growing or declining, ‘An increase in government expenditure is an injection in the circular flow on income. An injection is an addition to the circular flow of income SAVINGS HOUSEHOLDS TAXATION ———— PORTS Facer | + tacome cant) Goode " ‘Marleats: INVESTMENT FARVE + covernment SPENDING The diagram above illustrates some of the injections and leakages in the economy. Itis however very important to find out exactly what will be the effect on the economy from an increase in injections. Economists do this by calculating the ‘multiplier effect of the increase in the government expenditure on the economy. The ‘multiplier indicates how many times that the injection of original spending circulates through a local economy. Asa result of re-spending, it benelits the local people. The formula for calculating the multiplier effect is 1/(1-MPC). ‘When there is an increase in the government spending, the over all affect on the economy will depend on the multiplier, which depends on the marginal propensity to consume. This is because not all the money injected into the economy will be spent. ‘Some of it is saved. For example if the government’s expenditure increases by £10 rillion, people in the economy will have more money and they will spend more. How much the over all increase in the national incomes takes place will depend on the MPC. Ifthe MPC is 0.5 the multiplier will be 2. This means that the total increase in the national income will be: 10X2=£ 20million, ‘The main problem with calculating the multiplier is that extra spending could dissipate in inflation and therefore the true effect if the injections will not be known.WI marred oy Teachers This document was downloaded from wwww.markedbyteachers.com