the nature and importance of economics
TRANSCRIPT
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CHAPTER IITHE CIRCULAR FLOW
OF ECONOMIC ACTIVITY
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TWO BASIC ACTIVITIES UNDERTAKEN:
1.Production – perform by the firm2.Consumption- undertake by
households
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STOCK AND FLOW CONCEPTSSTOCK refers to the measure of quantity at a point of time.Example: an accumulation of a commodity like gasoline in a fuel tank
FLOW refers to the measure of movement of quantity over a period of time Example: income represents money earned per year is a flow.
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THE CIRCULAR FLOW OF GOODS AND SERICES AND INCOME
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THE PRODUCTION PROCESS- the process of producing goods and services involves household and firms in a circular flow.
LAND, LABOR, CAPITAL(Economic Resources)
GOODS AND SERVICES(Output)
FIRMS(Organizers and
users of Economic Resources)
HOUSEHOLDS(Resource Owners)
FIGURE 1: THE CIRCULAR FLOW OF THE PRODUCTION PROCESS
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FIGURE 2: THE FLOW OF OUTPUT BETWEEN FIRMS AND HOUSEHOLDS
RAW MATERIALSFIRM
INTERMEDIATEGOOD FIRMS
FINAL GOODSFIRM
HOUSEHOLDS
Raw materials
Intermediate goods
Final goods
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• Raw Materials are goods which are still unprocessed like wood, sand and iron ore.
• Intermediate goods are partially processed and still need further processing before they can be finally consumed.
• Final Goods are processed goods that are ready for final consumption like cassette players, candies and ready to wear clothing.
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FIGURE 3: THE CIRCULAR FLOW OF GOODS AND INCOME AMONG PRODUCERS AND
HOUSEHOLDS
HO
US
EH
OLD
SRAW
MATERIALS PRODUCERSINTERMEDIATE
GOODS PRODUCERS
FINAL GOODS PRODUCERS
ECONOMIC RESOURCES
PAYMENT
ECONOMIC RESOURCES
PAYMENT
ECONOMIC RESOURCES
PAYMENT
FINAL GOODS
PAYMENT
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INCOME FLOWWhen money is spent by households for consumption and firms for production, a circular flow of income is created. The expenditure of one unit becomes the income of another unit.
TWO DISTINCT CIRCULAR FLOWS AS FOLLOWS:
1. Between Households and firms, and2. Between Firms
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FIGURE 4: THE CIRCULAR FLOW OF INCOME BETWEEN HOUSEHOLDS AND
FIRMS
INCOME FLOW(Wages, interests,
rents)
INCOME FLOW(purchase of goods
and services)
HOUSEHOLDS FIRMS
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FIGURE 4: THE CIRCULAR FLOW OF INCOME BETWEEN FIRMS
RAW MATERIALS
FIRMS
INTERMEDIATE GOOD FIRMS
FINAL GOODS FIRMS
HOUSEHOLDS
Income Flow for purchase of raw
materials
Income Flow for purchase of
intermediate goods
Income Flow for purchase of final goods
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FIGURE 6: THE EFFECT OF REDUCTION OF PURCHASES
REDUCED INCOME(as a result of reduced purchases of economic
resources
REDUCED INCOME(as a result of reduced
purchases of goods and services)
HOUSEHOLDS FIRMS
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FIGURE 7: THE CIRCULAR FLOW OF GOODS AND INCOME IN A SIMPLE
ECONOMY WITH SAVINGS AND INVESTMENTS
FIRMS
HOUSEHOLDS
LAND, LABOR, CAPITAL
GOODS AND SERVICESRENT, WAGES,
INTEREST, PROFIT
PAYMENTS
SAVINGS
Investments
Capital goods
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GOVERNMENT
FIRMSHOUSEHOLDS
FOREIGN COUNTRIES
Land, labor capital
Rent, wages, interest
Goods and services
Payments for goods and servicespayments for imports
Payments for goods and servicesRent, wages, interest
Payments for exports