OCR A Level Economics: The circular flow, propensities and aggregate demand (H460) – Revision Notes

These notes condense the Circular flow of income and Aggregate demand topics of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, macroeconomics content. The specification labels no content AS or Extension. Full explanations and fuller worked examples are in the study guide. All figures are invented.

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Key definitions

Term	Meaning
Output method	Sum of value added by every sector
Income method	Sum of factor incomes: wages, rent, interest, profit
Expenditure method	C + I + G + (X − M) on final goods and services
Value added	Value of output minus the cost of inputs bought from other firms
Circular flow	Model of money, goods and factor services moving between households, firms, government, financial sector and overseas sector
Leakage (withdrawal)	Saving, tax or import spending that leaves the spending stream
Injection	Investment, government spending or exports that enter it
Physical flow	Movement of goods, services and factor services
Monetary flow	Payment moving in the opposite direction to a physical flow
Aggregate demand	Planned spending on home-produced output, shown against the price level
Accelerator	Net investment depends on the change in output, not its level

Formulas

Measure	Formula
APC	C / Yd
APS	S / Yd
MPC	ΔC / ΔYd
MPS	ΔS / ΔYd
MRT	ΔT / ΔY
MPM	ΔM / ΔY
MPW	MPS + MRT + MPM
Average propensity to withdraw	W / Y
Share re-spent at home	1 − MPW
Accelerator	Net investment = v × ΔY
AD	C + I + G + (X − M)

Relationships: APC + APS = 1 and MPC + MPS = 1 on disposable income. Equilibrium in the flow: W = J.

Method in steps

Calculating propensities

1. Decide whether the question wants average (whole amount) or marginal (change).
2. Check the base: Yd for consumption and saving, Y for tax, imports and total withdrawals.
3. Divide, and give the answer as a decimal or fraction.
4. If you know MPC, find MPS as 1 − MPC.

Using the accelerator

1. Find the change in output each year.
2. Multiply by the capital-output ratio.
3. Add replacement investment for gross investment.
4. Look at the change in growth to explain why investment rises or falls.

Reasoning chain for a shift in AD Trigger → which component changes → direction at every price level → shift left or right.

Small worked reminders

Output method. A farm sells grain for 25 to a mill, the mill sells flour for 60 to a baker and the baker sells bread for 100. Value added is 25, 60 − 25 = 35 and 100 − 60 = 40, a total of 100. The sales sum, 185, double counts.

Expenditure. C = 450, I = 110, G = 150, X = 120, M = 100: 450 + 110 + 150 + 120 − 100 = 730.

Average and marginal. Household with Yd = 5,000 and C = 4,200: APC = 4,200/5,000 = 0.84, APS = 0.16. If Yd rises by 80 and C by 60, MPC = 60/80 = 0.75, so MPS = 0.25.

Withdrawal. MRT = 0.28, MPS = 0.12, MPM = 0.10: MPW = 0.12 + 0.28 + 0.10 = 0.50. Half of extra income is re-spent at home.

Flow balance. S = 25, T = 45, M = 30, so W = 100. I = 50, G = 40, X = 20, so J = 110. J exceeds W by 10, so national income tends to rise.

Accelerator. v = 3, output up by 8: net investment = 24. Output flat: net investment = 0, so only replacement is left.

Must-know distinctions

• Average versus marginal: APC uses the whole of income; MPC uses only the extra.
• Physical versus monetary flows: goods and factor services versus payments. They move in opposite directions.
• Leakages versus injections: S, T, M versus I, G, X.
• Planned versus actual spending: AD is planned; national expenditure is measured.
• Movement versus shift: the price level moves you along AD; a change in planned spending on any component, whatever the price level, shifts it.
• Level versus change: the accelerator relates investment to the change in output, not the level.
• Gross versus net investment: gross includes replacement.

The AD curve

Axes: price level (vertical), real GDP (horizontal). The curve slopes down for three reasons.

• Wealth effect: higher prices cut the real value of money wealth.
• Interest rate effect: higher prices raise money demand and interest rates, cutting C and I.
• International trade effect: higher domestic prices hurt exports and favour imports.

Determinants and shifts

Component	Main determinants
C	Disposable income, interest rates, wealth, confidence, credit
I	Interest rates, expected returns, output growth (accelerator), technology, corporation tax, finance
G	Policy decisions, tax revenue, state of the economy
X − M	Exchange rate, relative prices, overseas income, trade barriers, home income

A rise in any component at a given price level shifts AD right. A fall shifts it left. A higher exchange rate tends to shift AD left, since X falls and M rises.

Evaluation prompts

Income and consumption: income is the main driver, but MPC is not fixed. It depends on who gets the income, whether the rise is expected to last, wealth, credit, interest rates and time lags.

Accelerator:

• For: explains why investment swings more than output.
• Against: spare capacity, uncertain expectations, finance and interest rates, a changing capital-output ratio, and lumpy investment.

Circular flow sketch

Households --- factor services (physical) ---> Firms
Households <-- wages, rent, interest, profit (monetary) --- Firms
Households --- consumer spending (monetary) ---> Firms
Households <-- goods and services (physical) --- Firms

Leakages: S (to financial sector), T (to government), M (overseas)
Injections: I (from financial sector), G (from government), X (overseas)

Equilibrium: W = J. If J is above W, income tends to rise; if below, it tends to fall.

Consumption function reminder

C = a + b·Yd, where a is autonomous consumption and b is the MPC. With a = 40 and b = 0.9, Yd = 300 gives C = 40 + 270 = 310, and Yd = 400 gives C = 400. The rise in C is 90 for a rise of 100 in Yd, so MPC = 0.9. APC at 300 is 310/300 = 1.03, so the household is spending more than its income, using savings or credit.

Chains of reasoning to learn

• Higher interest rates: dearer borrowing and better return on saving, so C and I fall, so AD shifts left.
• Rise in share and house prices: wealth rises, confidence improves, so C rises, so AD shifts right.
• Higher exchange rate: exports dearer abroad and imports cheaper, so X falls and M rises, so net exports and AD fall.
• Faster output growth: firms need more capital, so net investment rises, so AD rises. Slower growth does the opposite.
• Government spending cut: G is a direct component, so AD shifts left at every price level, with no change in the price level needed.
• Higher income tax rate: lower Yd, so C falls, so AD shifts left. A bigger MRT also raises MPW, so less of each extra unit of income is re-spent at home.

Quick self-test

1. State the formula for the average propensity to save.
2. Yd rises from 200 to 260 and C from 170 to 215. Calculate MPC and MPS.
3. Calculate APC at Yd = 260 when C = 215, to two decimal places.
4. A household group has MPS = 0.15, MRT = 0.25 and MPM = 0.20. Calculate MPW.
5. Define an injection and give two examples.
6. A bread chain has sales of 20, 50 and 90. Calculate the value added by the final firm.
7. The capital-output ratio is 4 and output rises by 6. Calculate net investment.
8. State two reasons why the AD curve slopes downward.
9. Name the effect of rising house prices on consumption.
10. Does a rise in imports shift AD right or left, and why?

Answers

1. APS = S / Yd.
2. MPC = (215 − 170) / (260 − 200) = 45/60 = 0.75; MPS = 0.25.
3. APC = 215/260 = 0.83.
4. MPW = 0.15 + 0.25 + 0.20 = 0.60.
5. Spending that enters the circular flow from outside household income and firm sales, such as investment, government spending or exports.
6. 90 − 50 = 40.
7. 4 × 6 = 24.
8. Any two of: wealth effect, interest rate effect, international trade effect.
9. The wealth effect: higher wealth tends to raise consumption.
10. Left, because imports are subtracted from AD in X − M.

Where marks are usually lost

• Dividing by the wrong base, such as using national income for the household APC.
• Reporting MPC as a percentage when a decimal was asked, or not stating the unit.
• Forgetting that value added subtracts inputs.
• Describing a leakage as an injection, especially saving.
• Treating a price-level change as a shift of AD.
• Listing determinants without explaining the chain to AD.
• Stating the accelerator without the word change.
• Evaluating only by listing, with no judgement on which factor matters most.

Official syllabus

These notes are aligned to the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, published by OCR.