Power Point Circular Flow1

7/30/2019 Power Point Circular Flow1

1/30

THE CIRCULAR FLOW OFECONOMIC ACTIVITY


2/30

Circular Flow-refer to a simple economic model whichdescribes the reciprocal circulation of income between producersand consumers

fundamental representation of macroeconomic activity

among the major players in the economy--consumers,

producers, government, and the rest of the world.Different versions of the model sequentially combined

the four sectors--household, business, government,and foreign--and the three markets--product, resource,

and financial--into increasingly more comprehensiverepresentations of the economy.


3/30

Basic Economic Activities

Production

The use of economic resources in the creation of goods and

services for the satisfaction of human wants.

Consumption

The using up of goods and services by consumer purchasing or

in the production of other goods.

Employment

The use of economic resources in production; engagement in

activity

Income Generation

The production of maximum amount an individual can spend

during a period without being any worse off.


4/30

Two Economic Units

Primary participants in the circular flow

of goods and services

Household and Firms

Household

The basic consuming unit.


5/30

This includes everyone, all people, seeking to satisfy

unlimited wants and needs. This sector is responsible for

consumption and undertakes consumption expenditures.

It also owns all productive resources.

Firm

The basic producing unit. This includes the institutions (especially proprietorships,

partnerships, and corporations-BUSINESS

ORGANIZATIONS)


6/30

that undertake the task of combining

resources to produce goods and services.

This sector does the production. It also

buys capital goods with investment

expenditures.


7/30

Two Types of Markets in the Circular Flow of

Goods and Services

ResourceMarketINPUT MARKET-is where

businesses purchase what they use to produce

goods and services. Resources are in the form

of labor, natural resources, capital, andentrepreneurship, all of which are supplied by

households.


8/30

Product markets-OUTPUT MARKETare

where goods and services are sold.

(MARKET STRUCTURES)

Other Sectors involved in the circularflow

Government sector: This includes the

ruling bodies of the federal, state, and localgovernments. Regulation is the prime function of

the government sector, especially passing laws,

collecting taxes, and forcing the other sectors to

do what they would not do voluntarily.


9/30

Foreign sector: This includes everyone

and everything (households, businesses,

and governments) beyond the boundariesof the domestic economy. It buys exports

produced by the domestic economy and

produces imports purchased by thedomestic economy, which are commonly

combined into net exports (exports minus

imports).


10/30

Stock and Flow Variables Flow

A quantity measured over a particular period of

time. Stock

A quantity measured as of a given point in time.

The concepts of stock and flow measurements areessential in understanding the economic variables ofwealth and income.

Wealth

Anything of valued owned. It is a stocksince it is what is owned at a particular

time. Income

The rate at which we earn money. It is aflow since income that is saved, increases

the stock of wealth.


11/30

Inflows and Outflows Outflows (factors that decrease the level of

economic activity)

Savings

Taxes

Imports Inflows (factors that increase the level of economic

activity)

Investment

Government Spending Exports


12/30

Outflows are difficult to control because they aredependent on income. When income increases,

we expect savings, taxes, and imports toincrease.

Inflows are easier to manipulate. The proper

use of policy enables the government toencourage exports and investments and to

increase its expenditures when it desires to

expand the flow of economic activity.


13/30

Savings-is setting aside a portion of a

persons income for future use

Inventory-normal quantity of goods

stored by the business firms for future

use(stocks)


14/30

Investment-The sacrifice of current

benefits or rewards to pursue an activity

with expectations of greater future benefits

or rewards. Investment is typically used to

mean the purchase of capital by business

in anticipation of the profit.


15/30

Taxes-Any sort of forced or coerced

payments to government. The primaryreason government collects taxes is to get

the revenue needed to finance public

goods and pay administrative expenses.


16/30

Three Sets of Policy

Monetary policyAffects the savings and investment.

Fiscal policy

Controls taxes and governmentexpenditures.

Trade policy

Affects a countrys exports andimports.


17/30

Four Models The Complete Model The circular flow model actually consists of four separate models, each

sequentially adding sectors or markets and thus providing greater complexity

and realism.

1. Two Sectors, Two Markets: The simplest circular

flow model contains two sectors (household and business)and two markets (product and resource). This model

highlights the core circular flow of production, income, and

consumption.


18/30

2.Two Sectors, Three Markets:A second versionof the circular flow model adds the financial markets.

This addition illustrates how saving is diverted from the

household sector to the business sector to financeinvestment expenditures.

3. Three Sectors, Three Markets:A third versionof the model includes the government sector. This modelhighlights the importance of taxes, which are also divertedfrom household sector income and used to finance governmentpurchases.


19/30

4. Four Sectors, Three Markets: The mostcomprehensive circular flow model includes the foreign sector.

Adding the foreign sector highlights the role of trade with the rest of

the world, especially exports and imports.

The complete circular flow model, with allfour macroeconomic sectors (household,business, government and foreign) and all three

macroeconomic markets (product, resource, and

financial), is presented in the above exhibit.


20/30

Economic Model of Production

The Circular Flow of the Production Process

HOUSEHOLDS

ECONOMICRESOURCES

GOODS ANDSERVICES

PRODUCING UNITS


21/30

Circular Flow of Goods Among Production Units

RAW MATERIAL FIRM

CONSUMERS

INTERMEDIATE GOOD FIRM

RAW MATERIALS

FINAL GOODS

INTERMEDIATE

GOODS

FINAL GOOD FIRM


22/30

The Circular Flow of Income

PURCHASES OF GOODS ANDSERVICES

INCOME FLOW OF WAGES,INTERESTS, RENTS

HOUSEHOLDSPRODUCING UNITS(

FIRMS)


23/30

The Circular Flow of Output and Income

Circular Flow of Physical Goods and Money Income

Goods and Services

Factors of Production

(land, labor, capital, entrepreneur)

Payments of Factors

(rent, wages, interest, profit)

Payment of Purchase

of goods and services.

Household

Sector

Business

Sector


24/30

Interrelation Between

Production Units & Households

HOUSEHOLDS RESOURCES

RESOURCES

RESOURCES

FINAL GOOD FIRM

INTERMEDIATE GOODFIRM

RAW MATERIAL FIRM


25/30

Circular Flow of Income Among Production Units

FINAL GOOD FIRM

RAW MATERIALSFIRM

MONEY PAYMENTS FORINTERMEDIATE GOODS

MONEY PAYMENTS FORRAW MATERIALS

INTERMEDIATE GOODFIRM

HOUSEHOLDSMONEY PAYMENTS FOR FINAL

GOODS


26/30

Economic Model of Income and Consumption

The Circular Flow of Goods and Income

Among Producers & Households

HOUSEHOLDS INTERMEDIATE GOOD

FIRM

RAW MATERIAL

FIRM

MONEY PAYMENT FOR PURCHASE OF FINAL GOODS

RESOURCES

MONEY PAYMENT FOR RESOURCES

RESOURCES

MONEY PAYMENT FOR RESOURCES

RESOURCES

MONEY PAYMENT FOR RERESOURCES

FINAL GOODS

FINAL GOOD FIRM


27/30

The Circular Flow of

Goods & Income of Households & Firms

with the Government & Foreign Countries

GOVERNMENT

HOUSEHOLDS PRODUCING UNITS

FOREIGN COUNTRIES

Income Payments of Wages, Rent,Dividends, & Interests

Purchase of Goods & Services

Economic Resources

Taxes Taxes

Wages, Transfer Payments Purchase of Goods& Services

Goods & Services

Money Payments forImports

Money Payments forExports


28/30

The Circular Flow ofEconomic ActivityReflecting The Outflows & The Inflows

HOUSEHOLDS PRODUCING UNITS

IncomePayments of Wages, Rent,

Dividends, & Interests

Purchase of Goods & Services

Economic Resources

Goods & Services

IMPORTS

TAXES

SAVINGS

EXPORTS

EXPENDITURES

INVESTMENTS

Foreign Countries

Government

Banks


29/30

Implications of the

Circular Flow of Economic Activity

1. The goods, resources, and money payments will flow as longas households continue to consume, and as long as firmscontinue to produce.

2. That since goods and resources flow in exchange forpayments, the rate of payments flow will in the end be thesame. Money is the inducing factor, and the pillar of the pricesystem. Without it, there is no price system.


30/30

- THE END -

GOOD DAY!!!

Power Point Circular Flow1

Documents

Transcript of Power Point Circular Flow1