Chapter 12 Study Guide
After reading Chapter 12, you should understand:
1. The circular flow of spending in the macroeconomy.
2. The role of leakages and injections in finding equilibrium in the macroeconomy.
3. The types of leakage and injections in the circular flow.
4. The role of economic policy in helping the economy to attain full employment without inflation.
5. How fiscal policy is used to improve the performance of the macroeconomy.
6. How monetary policy is used to improve the performance of the macroeconomy.
There is a circular flow of spending in the economy in which households supply resources in resource markets. Businesses demand resources to produce goods and services which they sell in product markets to households. In an economy without any leakages or injections, total spending will equal total output and there never would be any unemployment.
Leakages from the spending stream include savings, taxes and imports. Injections include investment spending, government spending and exports. When leakages equal injections, total spending will equal total output and the macroeconomy will be in equilibrium. If leakages exceed injections, then total output exceeds total spending and the level of national output (GDP) will fall. If injections exceeds leakages, then total spending exceeds total output and the level of national output will rise. Equilibrium may be reached at a level of GDP in which there is unemployment. If there is too much spending, GDP may reach equilibrium at a level in which there is inflation.
Economic policy is used to affect the levels of output, employment, and prices in the economy. There are two types of demand management policies: fiscal policy and monetary policy. Fiscal policy is conducted by Congress and the President and involves changes in government spending and/or taxes. In a recession, government spending is raised and taxes are lowered. Both lead to more spending in the economy and help to increase GDP. In an inflation, government spending is decreased and taxes are increased in an attempt to reduce spending in the economy. Monetary policy is conducted by the Federal Reserve System. The money supply is increased in a recession and reduced in an inflation.
Fill in the Blanks
The movement of money, resources and goods through the economy is known as _____1______. The macroeoconmy is in equilibrium when total _____2_____ equals total ____3____. Equilibrium also occurs where leakages equal injections. Leakages include _____4____, _______5____, and _____6____. Injections include ______7_____, ____8____, and ____9____. If total spending exceeds total output in the economy (or injections exceed leakages), then total output (GDP) will _____10____. If leakages exceeds injections, then total output will ____11____.
Changing taxes and government spending in order to affect the levels of output, employment and prices is known as ______12____. In a recession, taxes should be _____13____ and government spending should be ____14____. Changing the level of the money supply in order to affect the levels of output, employment and prices is known as ____15____. In a recession, the money supply should be ____16____, and in an inflation the money supply should be ____17___.
1. Circular Flow
7. Investment Spending
8. Government Spending
12. Fiscal Policy
15. Monetary Policy
Multiple Choice Questions
1. Which of the following is not considered to be a leakage in the Circular Flow Diagram?
a. Imports of goods and services
2. Which of the following is not considered to be an injection in the
Circular Flow Diagram?
d. Government Spending
3. If leakages in the economy exceed injections, then we can expect:
a. Inflation to be a problem in the economy.
b. Unemployment to fall.
c. Real GDP to fall.
d. Exports to increase.
4. The macroeconomy is in equilibrium when:
a. total spending equals total output.
b. leakages equal injections.
c. real GDP will not tend to change.
d. All of the above answers are correct.
5. If total spending in the economy exceeds total output, we can expect:
a. unemployment to rise.
b. real GDP to rise.
c. economic growth to fall.
d. that the economy is now in equilibrium.
6. Monetary policy is conducted by:
a. the President.
c. the Federal Reserve System.
d. the Secretary of the Treasury.
7. In a recession, Fiscal Policy would call for:
a. a decrease in government spending.
b. an increase in taxes.
c. changes in taxes and government spending so as to boost total spending in the economy.
d. increases in business inventories.
8. In an inflation, the Federal Reserve System should:
a. do nothing.
b. enact an expansionary monetary policy.
c. enact a contractionary monetary policy.
d. try to reduce interest rates in the economy.