circular flow and intro to macroeconomics

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Macroeconomics Week 4

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Page 1: Circular Flow and Intro to Macroeconomics

MacroeconomicsWeek 4

Page 2: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

CIRCULAR FLOW DIAGRAMis a visual model of the economy that shows how money flows through markets among households and firms.

Page 3: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

PRODUCTION,RESOURCES, &INCOMEFACTORS OF PRODUCTION Land (rent) Labor (labor) Capital (interest) ; and Entrepreneurship (profit)

Page 4: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

INTEGRATING PRODUCTION &AND CONSUMPTION

Money creates income every time it changes hands in the market system. On the other hand, the amount of money available for use in the two-household economy is not equal to income.

Income is a FLOW concept as it is generated and measured for a period of time.

Wealth is a STOCK concept as it refers to all materials which possess economic value owned by the populace.

Page 5: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

PRODUCTION UNITS &AND CONSUMPTION UNITS

Production is organized by FIRMS and not HOUSEHOLDS.

HOUSEHOLDS are resource owners (land, labor, capital, entrepreneurship)

FIRMS produce goods and services by utilizing the economic resources.

Page 6: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

PRODUCTION UNITS & CONSUMPTION UNITS

In this model, funds flow from FIRMS to HOUSEHOLDS, producing MONEY INCOME (wages, rentals, interests, and profits) for the HOUSEHOLDS arising from the use of resources.

Page 7: Circular Flow and Intro to Macroeconomics

THE CIRCULAR FLOW

HOUSEHOLD AND INTERDEPENDENT PRODUCTION UNITS

Not all firms produce consumer goods and there are stages of production to undergo to produce a final product or output.

Concept of Value Added: For each stage in the production process adds to the value of the final product.

It is the production of final goods and services that is relevant in arriving at national income

Page 8: Circular Flow and Intro to Macroeconomics

The Circular Flow of Economic Activity

THE CIRCULAR FLOW

INJECTIONS AND LEAKAGES

It is a fact that not all income and expenditures circulate continuously.

In reality, there are OUTFLOWS (Leakages) from and INFLOWS (INJECTIONS) into the circular flow.

Page 9: Circular Flow and Intro to Macroeconomics

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BANKSBANKS

SAVINGS(S)

TAXES(T)

GOVERNMENTGOVERNMENT

IMPORTS(M)

REST OF THE WORLDREST OF THE WORLD

INVESTMENT (I)

GOVERNMENT SPENDING (G)

EXPORTS (X)

5-SECTOR CIRCULAR FLOW

OUTFLOWS: Savings (S), Taxes (T), and Imports (M)

INFLOWS: Investment (I), Government Spending (G), and Exports (X)S + T + M

= I + G + X or OUTFLOWS

= INFLOWS