Eco Lesson 2

7/31/2019 Eco Lesson 2

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THE CIRCULAR FLOW

OF ECONOMICACTIVITY

Prepared by: Carolyn Yap-Mendoza


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Stock and Flow Concept Stock refers to the measure of quantity at a point of

time

It is an accumulation of a commodity

Flow refers to the measure of movement of quantityover a period of time.


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The Circular Flow of Goods,Services and Income

The basic aspects of the economy, which includeproduction and consumption, are subject to the stockand flow concept, which is circular in nature.


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The Production Process


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The Production Process The process of process of producing goods and

services involves households and firms in a circularflow.

The economic resources of land, labor and capital areprovided by the households and used by the producingfirms

These firms in turn, produce goods and services, which

are delivered to household for consumption.


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The Flow of Goods AmongProducing Firms

Within the circular flow of the production process isanother flow, which happens among different types ofbusiness firms.

This flow involves raw materials, intermediate goods,and final goods.

Raw materials are goods which are still unprocessed


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The Flow of Goods AmongProducing Firms

Intermediate goods are partially processed and stillneed further processing before they can be finallyconsumed

Final goods are processed goods that are ready forfinal consumption


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Firms can be classified as;

Raw materials producerslike those engaged inproducing agricultural products to be used inmanufacturing

Intermediate goods producers

like those producingconstruction materials

Final goods producerslike those producing productsfor final consumption or use


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Among Households andVarious Types of Producers

Households provide producers with economicresources required

These resources are distributed among various types

of producers

The producers in turn, remit payments to householdsfor the use of resources

When the goods are finally processed, these aredelivered to household, which in turn remit payments tothe concerned producers


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Income Flow When money is spent by households for consumption

and by firms for production, a circular flow of income iscreated.

The expenditure of one unit becomes the income ofanother


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Between Households andFirms

Firms for use in production buy the services of land,labor and capital.

As a result, money is paid to the households.

In turn, households buy the goods and servicesproduced by firms.

Money is paid by the households to the firms


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Between Firms Purchases are made between firms

The output of raw materials firms are sold tointermediate firms, which in turn sell their output to final

goods firms.

The final goods are sold for households forconsumption


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The Concept of Equilibrium The economy will be in equilibrium if the amount

received by the firms from households is equal to theamount received by households from firms.

Disequilibrium happens when either households orfirms do not spend all their incomes.

If household for one reason or another reduce theirpurchases, firms will receive a reduced amount of

income resulting to their incapability to maintain currentlevels of purchases from households


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The Concept of Equilibrium When firms actually reduce their purchases of

economic resources, some laborers will lose their jobs,and some land and capital will become idle.

The result is a corresponding reduction in the incomeof households.

Th Eff f S i d


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The Effect of Savings andInvestment

If the total output of firms are purchased by thehouseholds and the total economic resources arebought by firms, there is equilibrium in the market.

In reality, however, households allocate a part of theirincomes for the future use like providing money for oldage, as a result, disequilibrium happens, because firmsare hard pressed to dispose all their output.

The circular flow will tend to contract

Th Eff f S i d


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The Effect of Savings andInvestment

To prevent this from happening, some other means fordisposing the unsold portion of the output must betapped

Investment is a way of disposing unsold output

Firms spend money to procure goods and services forthe purpose of increasing their productive capacity inthe future.

In effect firms spend money now, to minimize theirexpenditures for capital outlay in the future.


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Government The government sector, which performs necessary

functions, buys economic resources of land, labor andcapital from households.

Land is used by the government to locate its buildingand facilities

Labor is hired to fill up various positions in the differentgovernment agencies


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Government Capital is borrowed to produce the necessary facilities

and services.

Payments in the form of wages, rents and interests are

remitted to the households by the government

Government money, however, is spent not on only inbuying economic resources from households but alsogoods and services produced by firms


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Foreign Countries Households purchase goods and services from other

countries,

The corresponding payment are sent to the exporting

countries

Local firms sell goods and services like agriculturalproducts to foreign countries

Payments are remitted to the local firms by foreignbuyers

Eco Lesson 2

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Transcript of Eco Lesson 2