Circular Flow – economic model showing income and product movements Product markets

Goods and services Total value of output

Factor (input or resource) markets Resources Factor payments = Income

wages rent interest profits

Expenditures: GDP = C + I + G + Xn C = consumer spending = f(income, interest rates)

Taxes (T) Consumer confidence

I = Business spending on plant and equipment (Investment) = f(interest rates, expected profits): Saving is necessary

Expectations of sales and profits Technology Business taxes

Government sector (G): Government spending on public goods = f(votes)

Foreign sector: Net Exports (Xn) = Exports (X) – Imports (Im)= f(exchange rates)

Exchange rates: rate at which two currencies trade Exports: goods purchased buy foreigners Imports: goods we purchase from foreigners

Income: GDP = C + S + T

Aggregate Demand – total dollar value of all planned expenditures AD Curve – inverse relationship between

the price level (GDP Price Deflator) and total quantity demanded

Shifts Components

Money Supply

Aggregate Supply – Real domestic output offered for sale by producers AS Curve - positive relationship between the price level (GDP Price

Deflator) and total quantity Shifts

Resource prices Productivity

Technology Education

Legislation Regulations

External shocks – come from outside the borders War – security costs OPEC Oil price increases 911

Internal shocks Weather and natural disasters Labor unions go on strike

Population Immigration Age

Equilibrium: Total quantity demanded = Total quantity supplied

Intersection of AD and AS

Natural (Potential) Real GDP: Economy is healthy Full employment Anticipated inflation 80 % Capacity

Gaps Contractionary Gap: Actual GDP < Natural

(Potential) GDP Sluggish economy Unemployment Could lead to a recession or depression

Expansionary Gap: Actual GDP > Natural (Potential) GDP

Overheating economy Overemployment Could lead to inflation