CIRCULAR FLOW MODEL

• In the United States mixed economy, there are three sectors, or elements, that interact:

•households•businesses•government

• Economists use the circular flow model to explain the interaction among these three sectors. Each sector of the economy contributes to another.

Circular Flow Model• I. Circular Flow Model

– A. Household & Firms– B. Factor Market

1.Where firms purchase or rent land2.Firms hire workers & pay salaries for

labor3.Borrow money from households to

purchase capital households interest or profits in return.

C. Product Market1.Households purchase products made

by firms

Circular Flow Model• II. Mixed Economy –

A. Government in the Factor Market1. Government purchases land, labor, & capital from households2. Government collect taxes from firms.

B. Government in the Product Market1. Government purchases goods & services = building, telephones, computers, fax machines2. Government provides goods & services = roads3. Government collect taxes from households

Business Cycle

Measuring Economic Activities

Gross Domestic Product GDP

• total market value($ value) of all the goods & services produced within the borders of a nation during a specified period.

• Usually reported on an annual basis• Per Capita GDP: nations GDP divided by

its population

Gross National Product (GNP)

• total market value($ value) of all the goods & services produced from a nation during a specified period.

• It includes inside & outside of the country

Consumer Price Index (CPI)

• Calculated each month by the Bureau of Labor Statistics• Price index determined by measuring the

prices of a “market basket”• Ex. Food, housing, medical care,

entertainment

Business Cycle

•not a regular, predictable, or repeating phenomenon like the swing of the pendulum of a clock.

•Its timing is random & unpredictable.

4 Phases of the Business Cycle

• A sequence of four phases.

• Expansion• Peak • Contraction• Trough

Phases of the Business Cycle

1. Expansion: speedup in the pace of economic activity & a rise in real GDP

•Recovery: right after a trough, economy is getting better

•Prosperity: right before a peak, economy is at its best•economic growth

2. Peak: upper turning of a business cycle•When GDP stops rising

Phases of the Business Cycle

• Contraction: slow down in the pace of economic activity

•Economic decline marked by falling GDP•Recession: 6 straight months of contraction

•Depression: Especially long contraction

• Trough: lower turning point of a business cycle, where a contraction turns into an expansion

•GDP stops falling

**A trough & peak both represent a turning point in the business cycle**

National Debt

• http://www.usdebtclock.org/

National Debt• the total amount of money the Federal

Government owes to bondholders.

• The debt is owed to investors who hold treasury bonds. If you invest in a treasury bond, the money that one uses to buy the bond is used to finance the National Government.

• A bond is essential an IOU issued by the government as a way for them to borrow money.

Problems of the National Debt

• Reduces the funds available for businesses to invest.

• The government must pay interest to bondholders, the more the government borrows, the more interest it has to pay.

• Roughly, to pay off the National Debt today, each citizen would have to pay just over $51,925

•When President Bush took office over 10 years ago, the national debt was at $5.6 trillion; since then, big budget surpluses have collapsed into huge deficits, & the debt has shot up more than 50 percent.

•When Obama took office it was $9.986 trillion

Business Cycle Activity• Please create the business cycle for the following items

on a separate sheet of paper…

• Ski Boots• Sun screen• Wool socks• Sandals • Summer Shorts