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5. The diagram below represents the Circular Flow of Income in an open economy without Government - Leaving Cert Economics - Question 5 - 2013
Question 5
5. The diagram below represents the Circular Flow of Income in an open economy without Government. (a) (i) State what each of the lines numbered 1 to 5 represents.... show full transcript
Worked Solution & Example Answer:5. The diagram below represents the Circular Flow of Income in an open economy without Government - Leaving Cert Economics - Question 5 - 2013
Step 1
State what each of the lines numbered 1 to 5 represents.
Answer
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Payment for factors of production: This line represents payments made by firms to households for the factors of production, namely wages for labor, rent for land, and profit for entrepreneurship.
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Spending on (domestic) goods & services: This line indicates household consumption where they purchase goods and services produced by firms.
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Savings: This is the amount of income that households decide not to spend but save, typically through financial institutions.
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Imports: This represents the goods and services that households purchase from foreign markets, leading to an outflow of money to other economies.
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Exports: This indicates the sales of goods and services from domestic firms to foreign markets, generating income for those firms.
Step 2
Referring to the diagram above, explain briefly the types of activities which take place between households and financial institutions.
Answer
Households save part of their income with financial institutions. This saving provides banks with the capital needed to lend to firms for investment. Additionally, these institutions may offer interest to households, incentivizing further savings.
Step 3
Referring to the diagram above, explain briefly the types of activities which take place between households and foreign markets.
Answer
Households purchase goods from abroad via imports, spending their income on foreign produced goods and services. This exchange allows households greater variety in consumption but leads to outflows of money to other economies.
Step 4
Referring to the diagram above, explain briefly the types of activities which take place between foreign markets and firms.
Answer
Firms export their goods and services to foreign markets. These exports generate income and help sustain production levels within the domestic economy while also integrating it into the global market.
Step 5
Outline two economic reasons for this development.
Answer
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Increased unemployment: Higher unemployment rates reduce disposable income, leading to decreased consumer spending.
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Increased taxation: Higher taxes on individuals lead to lower disposable income, further limiting spending capabilities.
Step 6
Discuss two actions which the government could take to increase consumer expenditure.
Answer
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Decrease VAT rates: Lowering VAT would reduce the prices of goods, encouraging consumers to spend more.
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Provide incentives to consumers to spend: Programs such as cash vouchers or tax rebates could incentivize consumers to increase their spending, stimulating the economy.