Investment Spending


Q1.Whydoes investment spending not equal saving in the circular flow?&nbsp

Thereare several reasons why investment spending is not equal to spendingin the circular flow model. Firstly, there are activities thathouseholds do with money rather than investing in it. Households gettheir income from business in the circular flow model (McEachern,2012).Then, they spend all the income from the business buying goods andservices. Conversely, this is not true. Nevertheless, the householddoes other things such as saving. The saved money goes to businessfor investment purpose. Consumers still engage in consumption, buyinggoods and services, pay taxes among other things. Therefore,investment spending is not equal to all spending in the circular flowmodel.

Q2.Whydoes the consumer price index exaggerate the inflation rate?&nbsp

ConsumerPrice Index is a variation in prices of common goods and services.The CPI is prone to exaggerate the inflation rate, as well asimplement changes in the formula. This also include additionalvariable like the qualitative factors and product substitution.Therefore, CPI does not reflect the actual inflation rate as themeasure of its effects on consumer. McEachern(2012),states that the process that derives it is imprecise. In addition,the CPI provides good estimate of inflation rate though it issubjected to error that may leads to under or over estimation of theinflation rate.

Q3.Whydo total leakages and total injections have to be equal?&nbsp

Thetotal leakage has to be equal to total injection in the circular flowmodel because the total amount of money entering sector of economyhas to be equal to the total amount of money leaving the economy. Ina normal circular flow model, households gain their income from theservices they give to their businesses (McEachern,2012).In return, they spend all the money they receive to buy all goods andservices that the business creates. Therefore, the total leakagesmust be equal total injections.

Q4.Discuss the limitations of national income accounting.&nbsp

Nationalincome accounting has several limitations. Firstly, national incomeaccounting ignores quality of life. It only measures the amount ofmoney made in an economy and ignores the happiness of people.Secondly, it does accounts for activities with negative consequences,and only concentrates on those with positive consequences. Accordingto McEachern(2012),national income accounting does not account for all national income.For instance, it ignores the black market.


McEachern,W. A. (2012). ECON Macro 3 (3rd ed.). Mason, OH: South-Western.&nbsp