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If the circular-flow model is in equilibrium (the sum of money flowing into each box is equal to the sum of the money flowing out of it) and there is an increase in government spending, holding everything else constant, which outcome is likely to occur?

User Zout
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2 Answers

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Final answer:

An increase in government spending within an equilibrium circular-flow model will likely lead to economic growth due to the multiplier effect, where initial government spending generates a cycle of increased expenditures that lead to a greater increase in real GDP.

Step-by-step explanation:

If the circular-flow model is in equilibrium and there is an increase in government spending, holding everything else constant, we would anticipate that the outcome is likely to be economic growth. This growth is due to the multiplier effect, which ensures that an increase in spending leads to a larger increase in the equilibrium level of real GDP.

The reason for this is that when the government spends more, this initial spending is received as income by households or firms, who then spend it again, leading to a series of expenditures that are greater than the original amount. This cycle of spending contributes to increased aggregate demand in the economy, which in turn prompts firms to increase production and potentially leads to more jobs and income, thus further expanding the circular flow of economic activity.

User BerticusMaximus
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5 votes

Answer:

increase in nominal GDP due to an increase in the general level of prices (inflation).

Step-by-step explanation:

In the circular flow model, households represent the primary demand of goods and services, which are mostly supplied by businesses. The money flows in opposite as goods and services flow towards households, while factors of production flow towards businesses. Households purchase goods and services from businesses, while they sell factors of production to businesses. Household's savings = investments, inject money into the circular flow.

When governments increase spending, and everything else remains constant, the inflation rte will increase, resulting in an increase in the nominal GDP, but the real GDP will not be affected.

User Sheresa
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