Learning Objectives:

Measuring the Economy

LO1: Understand the circular flow of national income

LO2: Explain the concept of equilibrium and why national income can rise and fall

LO3: Understand the components of GDP accounting and be aware of some of the problems in determining official statistics

CHAPTER 3

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Circular Flow of Income

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LO1

• Simplified economy with two sectors

BusinessesHousehold

s

Circular Flow of Income

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LO1

• Businesses sell goods & services to households

• Households provide factors of production to businesses

BusinessesHousehold

s

Goods and services

Factors of production

Circular Flow of Income

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LO1

• Households pay for goods and services

• Businesses pay for factors of production

BusinessesHousehold

s

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

Consumption • Household spending on goods and services

Product Market• The market for consumer goods and services

Factor Market• The market for factors of production

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LO1

Circular Flow of Income

Circular Flow of Income

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LO1

BusinessesHousehold

s

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

Product Market

Factor Market

Circular Flow of Income

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LO1

BusinessesHousehold

s

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

National Income: sum of all spendingOR sum of all incomes earned

Stock of Money • Quantity of money at a specific point in time

Flow of Income • Amount of income over a given period of time

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LO1

Stock vs Flow

Leakages

Leakage – Income received within the circular flow that does

not flow directly back

1.Savings 2.Taxes less transfer payments

- transfer payment: one-way transaction where payment is made but no good or service flows back

3.Imports

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LO1

Injections

Injection – Any spending flow that is not dependent on the

current level of income

1.Investment (on capital goods) 2.Government spending3.Exports

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LO1

Leakages and Injections

Leakages

1. Savings 2. Taxes 3. Imports

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LO1

Injections

1. Investment 2. Govt spending3. Exports

Saving and Investment

• Saving is that portion of income that is not spent on consumption

• Important source of loanable funds • The amount of savings in the economy

depends primarily on the level of incomes

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LO1

Y = C + S

S = Y - C

Circular Flow of Income

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LO1

Businesses

Households

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

Financial Intermediarie

s

SavingInvestment

Imports and Exports

• When goods & services are imported, Canadian payments leak out to another country – imports are a leakage

• When goods & services are exported, foreign payments are injected into our economy

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LO1

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LO1

Businesses

Households

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

Financial Intermediarie

s

SavingInvestment

ForeignSector

$ Paymentfor Imports

$ Paymentfor Exports

Taxes and Government Spending

• Governments collect taxes from households and businesses – which leak out of the economy

• Tax revenues may be used for government spending programs – which are injections

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LO1

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LO1

Businesses

Households

Goods and services

Factors of production

$ Consumption spending

$ Rent, wages, interest, profit

Financial Intermediarie

s

SavingInvestment

ForeignSector

$ Paymentfor Imports

$ Paymentfor Exports

GovtT T

TPG