okay guys and what we want to do in um this video and which is most likely the final video of the circuit flow of income and we want to complete the model and we want to ask a few questions about how government can get involved okay so again i must stress we're talking about national income talking about macro economics the economy as a whole and what we're trying to do is develop a very early and rudimentary model that we can use to analyze the economy and think about how a change in spending can affect other macroeconomic variables so kind of just to start from the start and build the whole thing up from scratch we said that we had irish firms and irish households they were the only two groups in the economy and what irish households did was spend their money on the output on the stuff they bought stuff off shops or firms of irish firms and then irish firms would then put that money back into the irish households because the irish households or the households in general own the firms then we also said was well households don't spend all of their money what they actually can do is not spend some of their money on irish firms output and they could save it but then we said that comes back into the circular flow of income that comes back to irish firms particularly if there isn't a recession and financial institutions are lending in the term in the form of investment okay so that's another thing that's very important there right so um savings reduces um the incentive for irish firms to produce lowering national income lowering uh employment and investment increases the demand for the the output of irish firms increasing um um output increasing employment increasing um national income we also said was that even if irish households do spend all of their money and they don't necessarily spend it all on irish produced goods and services so instead of this kind of injection of money into the irish firms what we see is that some money from irish households can go to foreign firms okay and and increase their incentive to produce goods and services and that's what we refer to as imports then also however though people in other countries can buy the goods and services or at least some of the goods and services that we produce and we call those exports now the final kind of player in the circular flow of income is one that is very difficult to get away from in this life and that is essentially the government now what we are saying is that irish households don't get to keep all of the money that they earn the government will take some of that in taxation and the definition of taxation is a contribution required from households and firms in order to finance the running of the country but the government tends not to just keep all of that money the government is supposed to use that money to make your and my lives better and so what they do is they spend that sometimes on the direct provision of goods and services if they build themselves and government housing or other times they could subsidize firms in the economy in general a large market of course we're talking about macro economics and to produce goods and services and for people that may require them so basically what we're saying is that the way that government influences the economy is through taxation and spending taxes they reduce what is called disposable income disposable income is your income minus taxation that's how much you get to spend well if they reduce the amount that households can spend well that certainly will reduce the amount that they can spend on the on the output of irish firms however the story doesn't end there what they actually do with that money is then turn around and invert doesn't always have to be of course because like this diagram can be far more complex and i'm keeping it as simple as possible i think it's very important to do i have seen um wonderful people online and go into much greater detail i don't know i i'm not convinced that the um extra detail um leads to greater understanding in fact i think it leads to greater confusion so hence i've tried to keep this simple so what we are saying is that the government can then turn around and spend some of our taxes on um in irish firms or in um on the output of of domestic firms and as such caused them to increase their output to uh increase the demand for their goals and services causing them to increase their output causing them to employ more workers causing them to produce more and as such if enough firms do that then that's an increase in national income so as always i would ask you to draw the diagram as is okay and pause it here draw this and then like the rest of the videos on circular flow of ink and once you've finished drawing that diagram what i would like you to do is go down to the questions that follow so um there's a list of questions here so draw the diagram on the previous page and have a look at these questions see if you can answer them and then once you have answers um press play and i'll go through my opinion on them okay so i hope you've had a chance to answer those questions so what i'm just going to do is go through them one by one as always okay so how can the government influence an economy a very short answer is through taxation and spending essentially that's what we call um fiscal policy fiscal policy okay so let's delve deeper into that okay so if the government increases spending how does this affect the economy all right well an increase in government spending increases the flow of money to domestic firms increases the demand for goods and services produced by these domestic firms so if the demand for them increases they have an incentive to meet that increased demand in order to try and achieve higher profits but this we're not just talking about one firm or a group of firms what we're trying to say is that one way the government can influence the entire economy is by just spending more money on domestic on the output of domestic firms that will cause them to produce more how will they produce more will try and hire more people okay if they produce more and if enough firms produce more then what we have is an increase in national income okay if the government reduces spending how does this affect the economy a reduction of government spending reduces the flow of money to domestic firms it reduces the demand for the goods and services that they produce if there is a reduction in government spending and that leads to a reduction in demand well then firms will reduce the amount of goods and services that they produce if that happens well then what happens to national income well if enough firms do that then national income will fall okay so all we're saying is if less is produced in the economy brought about by a reduction in aggregate demand total demand for all domestically produced goods will then national income will fall so they're the first three questions on on the previous slide uh questions four and five if government increases taxes how does this affect the economy well a general way of looking at this is that and i suppose maybe a better question would be how does it affect national income like for the previous ones an increase in taxation reduces the flow of money to domestic firms why because if you take more money off households and if you take more money off firms households are less able to demand goods and services from firms and then firms are less able to pay other firms they they can't afford it because all of their money's been taken in corporation tax or corporate taxes so therefore um the total demand for goods and services falls why where is that demand gone well it's gone into the government coffers okay that demand represented by money has gone into the government account and therefore people and firms can afford to buy less off other firms so if the demand for goods and services falls because households and firms have less money as a as a result of an increase in taxation well then what will occur is they'll produce less and if they produce less that's the definition if if firms in the economy produce less goods and services that's the definition of a full and national income okay and if the government reduces taxes well then the opposite is true well then households have more money they're richer okay firms don't have to pay as much corporation tax they can afford to engage in more investment projects so reduction in taxation increases the flow of money to domestic firms and what that means is that there's an increase in demand for what they are producing if that happens as a result of a higher disposable income well then what that means is that firms have a profit incentive all firms have a profit incentive in order to try to meet this increase in demand and what will they do well they will produce more goods and services usually by employing more factors of production in this case what we're talking about or have been talking about is labor and they'll employment will rise and more goods and services will be produced to meet that higher demand and as such national income rises so that's the whole idea of this idea of circular flow of income which is that if you allow more now i'm not just talking about printing money we'll talk about that when we come to monetary policy but i'm just saying if you allow people to buy more off domestic firms if aggregate demand increases for the output of domestic firms if people want to buy more goods and services at different price levels from domestic firms well then they will um react by trying to meet that increased demand and that means they have to produce more and more goods and services and that by its definition is an increase in real gdp if on the other hand government through increased taxation or reduction in government spending um and reduces the aggregate demand in the economy for the output of domestic firms well they will also react to that reduced demand by reducing the amount that they produce which in and of itself is the definition of a reduction in real national income in real gdp in real why okay uh why i mean the letter y capital letter y standing for income and economics so what i have done here is kind of giving you three i suppose potential effects of an increase in in aggregate demand in general in the demand for domestically produced goods so name two likely effects of the government both increasing spending and reducing taxes well that's a double-edged sword because they're increasing the demand for domestically produced goods and services and they're also increasing the real the disposable income of households which in turn as a result that they're richer that means that they can spend more money on the output of domestic firms so therefore the demand for goods and services aggregate demand in the economy rises the demand for domestically produced goods and services has increased well what do firms do well they try to meet that increase in aggregate demand simply because and they have a profit incentive to do so well how do they do that well they increase employment if employment increases what happens um to national income well more factors of production are being used so therefore they're going to make more stuff so national income rises now also you have to think about this if there's an increase in demand in general for all goods and services if every shop owner sees that people want to buy more and more of their goods and services what would they do with their prices and most likely they would increase them and that's what an increase in inflation is an increase in the sus or sustained increase in the general level of price not just the price of one good but the price of all goods in the economy that's what inflation is when the price of all goods on average in the economy rises that's what inflation is and where could the government get the revenue to increase spending if it cannot raise taxes so if it's reducing taxes and increasing spending well what they're going to have to do is borrow it that's going to cause an increase in the national debt okay combined the combined deficits of previous governments all right and what that's going to do is that's going to cause aggregate demand to increase and where should they get that money from well preferably from abroad and when we're studying um fiscal policy we'll see that there's this thing called the crowding out effect and we'll see that the government should never try to cause that to happen so if they could um borrow from bank banks abroad that wouldn't affect the demand and supply for investment goods or for excuse me for loanable funds in the domestic economy now please do not concern yourself if six and seven don't make sense to you yet all i'm just saying to you right now is that um i want to kind of shape your thinking in the future that an increase in the demand for everything most likely will increase employment most likely would increase national income most likely will increase inflation doesn't always happen and doesn't always have to happen or at least all of them at the one time but what we will see later on is is a better more complete model called the aggregate demand aggregate supply curves um where we can analyze what would happen and why at different stages or or of um production and different government interventions guys thank you so so much for watching before i let you go there is one final thing that i really need to bring in to your attention if we look at the circular flow of income diagram we have seen that savings imports and taxes all of those cause less money to go from irish households to irish firms all of those reduce what is called aggregate demand the total demand for domestically produced goods and services the total demand the total spending on the output of irish firms all of those caused that to reduce all of those therefore at least should or most likely would lead to a reduction in national income because they are reducing the demand for domestically produced goods and that means that the irish firms won't have the incentive to produce as much as they would they would reduce the amount that they produce and as such cause national income to fall because a reduction in total country-wide production is by definition a fall in national income for that reason these are seen to be leakages out of the domestic economy a leakage is any um situation or or any payment that is not spent in the domestic economy okay because taxes aren't spent i know that we'll come to that side in a second but savings aren't spent that is literally the definitions of saving that portion of income which is not spent imports are not spent in the domestic economy they are spent but they're not spent in the domestic economy and taxes aren't spent okay but if we look at the right hand or excuse me the left-hand side i do apologize all of these investment the production or purchase of capital goods exports the demand for domestically produced goods by foreigners and government spending any spending by the government on current and capital projects all of those three things boom increase the demand for irish produced goods and services increase the demand for domestically produced goods and services that will give them an increase incentive essentially these increase aggregate demand and these reduce aggregate demand leakages reduce aggregate demand reduce the incentive for production from domestic firms and as such have a tendency to cause national income to fall and injections increase in aggregate demand increase the demand for domestically produced goods and services and as such um and provide an incentive for total production and national income to rise i really really hope that makes sense guys thank you so so much for watching and i hope to see you again in the next video