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(J) the circular flow model


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(J) the circular flow model

  1. 1. The Circular Flow of Economic Activity<br />
  2. 2. Review of Microeconomic Activities:<br />Markets for factors (inputs) of production<br />Markets for goods and services<br />Buyers<br />Markets for goods and services<br />Markets for factors (inputs) of production<br />Sellers<br />
  3. 3. Review of Microeconomic Activities:<br />Optimal satisfaction<br />AsBuyers<br />Minimal Cost<br />Maximum Income<br />Profit Maximization<br />AsSellers<br />
  4. 4. Review of Microeconomic Activities:<br />Consumer Surplus<br />Producer Surplus<br />Surplus <br />
  5. 5. From Microeconomic Analysis to Macroeconomic Analysis:<br />First, analysis of markets (microeconomics)<br />Next, analysis of economic sectors (macroeconomics):<br />2-Sector Circular Flow (basic sectors directly connected to the markets; basic economy)<br />5-Sector Circular Flow (3 additional sectors to complete the economy)<br />
  6. 6. The Basic (2-Sector) Circular Flow Model<br />a simple economic model which describes the reciprocal circulation of income between producers and consumers.<br />In the circular flow model, the inter-dependent entities of producer and consumer are referred to as "firms" and "households" respectively and provide each other with factors in order to facilitate the flow of income. <br />Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households.<br />
  7. 7. MARKETS<br />FOR<br />GOODS AND SERVICES<br /><ul><li>Firms sell</li></ul>Goods and<br />Goods<br /><ul><li>Households buy</li></ul>services<br />and services<br />bought<br />sold<br />HOUSEHOLDS<br />FIRMS<br /><ul><li>Buy and consume
  8. 8. Produce and sell</li></ul>goods and services<br />goods and services<br /><ul><li>Own and sell factors
  9. 9. Hire and use factors</li></ul>of production<br />of production<br />MARKETS<br />Labor, land,<br />Factors of<br />FOR<br />and capital<br />production<br />FACTORS OF PRODUCTION<br /><ul><li>Households sell</li></ul>Wages, rent,<br /><ul><li>Firms buy</li></ul>and profit<br />The Basic 2-Sector Circular Flow Model (w/ details)<br />Spending<br />Revenue<br />Income<br />= Flow of inputs <br />and outputs<br />= Flow of money<br />Copyright © 2004 South-Western<br />
  10. 10. The Basic (2-Sector Circular Flow Model<br />
  11. 11. The Basic (2-Sector Circular Flow Model<br />Assumptions: (ideal situation)<br />The economy consists of two sectors: households and firms.<br />Households spend all of their income (Y) on goods and services or consumption (C). There is no saving (S).<br />All output (O) produced by firms is purchased by households through their expenditure (E).<br />There is no financial sector.<br />There is no government sector.<br />There is no international sector.<br />
  12. 12. The Basic Circular Flow Model<br />The Simple Maths:<br />Y = E<br />E = C<br />C = O<br />/.: Income Perspective: Y = C<br />
  13. 13. The 5-Sector Model<br />A more realistic representation of the economy.<br />Unlike the two sector model where there are six assumptions the five sector circular flow relaxes all six assumptions. <br />Since the first assumption is relaxed there are three more sectors introduced.<br />
  14. 14. The 5-Sector Model<br />The Three Additional Sectors:<br />The Financial Sector <br />The Government Sector<br />The International (or Overseas) Sector<br />
  15. 15. The 5-Sector Model<br />Income (Y)<br />Resources<br />HOUSEHOLDS<br />FIRMS<br />Output (O)<br />Consumption/Expenditures (E)<br />INJECTIONS<br />L E A K A G E S<br />Savings (S)<br />Investments (I)<br />FINANCIAL SECTOR<br />Government Spending (G)<br />Taxation (T)<br />GOVERNMENT SECTOR<br />Imports (M)<br />Exports (X)<br />INTERNATIONAL SECTOR<br />
  16. 16. The 5-Sector Model<br />LEAKAGES<br />Savings (S)<br />Taxes (T)<br />Imports (M)<br />INJECTIONS<br />FINANCIAL SECTOR<br />Investments (I)<br />Government<br /> Spending (G)<br />Exports (X)<br />GOVERNMENT SECTOR<br />INTERNATIONAL SECTOR<br />
  17. 17. The Basic Circular Flow Model<br />The Simple Maths:<br />Since Y = C + S + T + M<br /> Y= C + I + G + X<br />Then, S + T + M = I + G + X<br />(Leakages) (Injections)<br />
  18. 18. The Basic Circular Flow Model<br />If:<br />S + T + M = I + G + X<br />S + T + M > I + G + X<br />S + T + M < I + G + X<br />Then, we have a:<br />More or less Stable Economy.<br />Contracting or Shrinking Economy.<br />Growing economy.<br />