2.4.1 The circular flow of income Quiz: Pearson Edexcel Economics A, Unit 2

The 20 questions

1. Which statement correctly describes the two-sector circular flow model?

   • Households pay firms directly for factor services, which firms return to households in the form of finished goods
   • Households supply factor services to firms, and firms pay households wages, rent, interest and profit in return
   • Government supplies all factor services, and firms pay wages to households, so the public sector supplies all productive inputs
   • Firms supply factor services to households, and households pay firms wages for the goods that firms sell in the market

2. In the simple two-sector circular flow model, households supply which resource to firms?

   • factor services such as labour and capital
   • imports of raw materials from abroad
   • finished goods for sale in the market
   • tax payments to the government

3. The circular flow of income model shows that:

   • income and expenditure are always unequal, so the economy is never in balance and flows keep moving apart
   • total income in the economy equals total expenditure and total output, with flows linking households and firms
   • households save all their income, so firms never receive any spending and the flow of income stops at households
   • total output is determined by the money supply rather than spending, so changes in money in circulation set production

4. Which of the following is the best definition of income in the circular flow?

   • a flow of payments to factors of production, such as wages, rent, interest and profit
   • the value of imports minus exports in a given period
   • the total value of goods bought by the government in a year
   • a stock of wealth such as property and shares held at a moment in time

5. The distinction between income and wealth is that:

   • wealth is measured per year, while income is measured as a single balance
   • income is a stock measured at a point in time, while wealth is a flow over a period
   • income is a flow measured over a period, while wealth is a stock measured at a point in time
   • income and wealth are identical concepts used interchangeably in economics

6. A household with income of 40,000 a year and savings of 10,000 holds a house worth 200,000 with no mortgage. Which best describes its wealth?

   • the difference between its income and its spending in the year, which measures how much the household has added to wealth
   • the 10,000 of savings only, since the house is not a financial asset and cannot be counted in household wealth
   • a stock of assets including the house and the savings, which together give its total wealth
   • the 40,000 annual income only, since wealth is simply the amount a household earns each year from wages and other sources

7. In an economy with no government and no trade, national income equals:

   • investment plus exports minus imports
   • consumption plus saving
   • consumption plus investment plus government spending
   • government spending plus taxes minus transfers

8. Which best describes how the circular flow is affected by a rise in household saving that is not borrowed by firms?

   • spending in the circular flow rises, because households hold more savings
   • the circular flow is unaffected because saving is not a flow
   • firms receive more revenue as households save more of their income
   • spending in the circular flow falls, so firms' revenues and incomes may fall

9. Which best describes the link between production and income in the circular flow?

   • the value of output produced equals the income earned by factors of production in the same period
   • income is determined by government spending alone, not by production
   • the value of output is always larger than income because firms also earn profit
   • output equals income only in an economy with no households

10. Which of the following would be a flow in the circular flow model rather than a stock?

    • the stock of machinery held by a firm
    • wages paid to workers in a month
    • the balance in a household's savings account
    • the value of a house owned by a household

11. A rise in household incomes in a closed economy, with saving rates constant, is most likely to:

    • leave output and income unchanged because the flows are independent, so changes in household income never reach firms
    • reduce consumption because households save more as income rises, so firms sell fewer goods and the circular flow shrinks
    • reduce output because firms earn less revenue from higher incomes, since households choose to hold cash rather than spend
    • increase consumption and firms' revenues, raising output and income in the circular flow

12. In an economy with a government sector, which flow leaves the circular flow of income?

    • exports sold to foreign buyers
    • taxes paid by households and firms to the government
    • government spending on goods and services from firms
    • payments of wages to households by firms

13. A UK household pays 2,000 in income tax and receives 1,500 in state pension. What is the net effect of this on the household's disposable income in the circular flow?

    • a net injection of 500 into the household's disposable income
    • no effect, because taxes and transfers always cancel out in the circular flow
    • a net withdrawal of 500 from the household's disposable income
    • a net withdrawal of 3,500 from the household's disposable income

14. Which statement best evaluates the circular flow model as a representation of the economy?

    • It shows that the economy is always in equilibrium with no flows at all, so money, goods and services never move between sectors
    • It is a complete and exact description of every economic transaction, so it captures all flows of money, goods and services
    • It is a simplified model, useful for showing flows, but it ignores stocks such as wealth and the distribution of income
    • It is useless because it does not include households or firms, so it cannot describe how money and goods move between sectors

15. Why does the circular flow of income model help policy-makers?

    • It proves that government spending always crowds out private spending, so any public expenditure reduces private activity
    • It shows that only households matter for the economy, since firms and government play no role in creating or distributing income
    • It shows how spending, income and output are linked, so policy can be assessed for its effect on the whole economy
    • It shows that policy has no effect on income because flows always balance, so any spending change is offset by the market

16. A firm pays 100,000 in wages and 20,000 in rent. From the household perspective, what is total factor income?

    • 20,000
    • 120,000
    • 80,000
    • 100,000

17. In the circular flow, what is the role of financial intermediaries such as banks?

    • They remove money from the circular flow permanently by holding it as cash, so saving never returns to firms or households
    • They supply factor services directly to firms, so banks themselves provide the labour and capital used in production
    • They channel household savings to firms for investment, so saving is an injection into the flow
    • They pay taxes on behalf of households to the government, so the state receives tax revenue through the banking sector

18. Which statement about income and wealth in an economy is most accurate?

    • Income is always larger than wealth in any economy, because wealth is only a small share of the earnings households receive
    • Wealth is a flow of spending while income is a stock of assets, so households earn wealth each year and hold income as savings
    • Wealth and income always move together in every household, so a rise in income always raises wealth by the same proportion
    • A household can have high wealth but low income, such as a retired household living off savings

19. What is the significance of the distinction between income and wealth for measuring economic welfare?

    • Welfare depends only on income, and wealth has no effect on living standards, so households with large assets are no better off
    • Welfare is measured entirely by government spending per head, so public expenditure alone determines how well off people are
    • Welfare depends only on wealth, and income is irrelevant to living standards, since asset values determine how households live
    • Welfare depends on both current income and accumulated wealth, so a measure of income alone can miss important differences

20. Which of these is an example of factor income?

    • a state pension paid to a retired worker, recorded as a transfer and paid from the government's current tax receipts each year
    • rent received by a landlord for letting out a property
    • a gift of money from a parent to a child, recorded as a private transfer that moves income between households without any work
    • unemployment benefit paid to a jobseeker, recorded as a transfer payment made by the state to people who are out of work

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