Circular Flow and Intro to Macroeconomics

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Circular Flow and Intro to Macroeconomics

  1. 1. Macroeconomics<br />Week 4<br />
  2. 2. CIRCULAR FLOW DIAGRAM<br />is a visual model of the economy that shows how money flows through markets among households and firms. <br />
  3. 3. PRODUCTION,<br />RESOURCES, &<br />INCOME<br />FACTORS OF PRODUCTION<br /><ul><li>Land (rent)
  4. 4. Labor (labor)
  5. 5. Capital (interest) ; and
  6. 6. Entrepreneurship (profit)</li></li></ul><li>INTEGRATING PRODUCTION&<br />AND CONSUMPTION<br />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. <br />Income is a FLOW concept as it is generated and measured for a period of time. <br />Wealth is a STOCK concept as it refers to all materials which possess economic value owned by the populace. <br />
  7. 7. PRODUCTION UNITS &<br />AND CONSUMPTION UNITS <br /><ul><li> Production is organized by FIRMS and not HOUSEHOLDS.
  8. 8. HOUSEHOLDS are resource owners (land, labor, capital, entrepreneurship)
  9. 9. FIRMS produce goods and services by utilizing the economic resources.</li></li></ul><li>PRODUCTION UNITS &CONSUMPTION UNITS <br />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. <br />
  10. 10. HOUSEHOLD AND INTERDEPENDENT PRODUCTION UNITS<br /><ul><li>Not all firms produce consumer goods and there are stages of production to undergo to produce a final product or output.
  11. 11. Concept of Value Added: For each stage in the production process adds to the value of the final product.
  12. 12. It is the production of final goods and services that is relevant in arriving at national income</li></li></ul><li>THE CIRCULAR FLOW<br /><ul><li> In reality, there are OUTFLOWS (Leakages) from and INFLOWS (INJECTIONS) into the circular flow.</li></ul>INJECTIONS AND LEAKAGES<br /><ul><li>It is a fact that not all income and expenditures circulate continuously.</li></ul>The Circular Flow of Economic Activity<br />
  13. 13. 9 of 46<br />5-SECTOR CIRCULAR FLOW<br />EXPORTS (X)<br />GOVERNMENT SPENDING (G)<br />INVESTMENT <br />(I)<br />BANKS<br />GOVERNMENT<br />REST OF THE WORLD<br />SAVINGS<br />(S)<br />TAXES<br />(T)<br />IMPORTS<br />(M)<br />INFLOWS: Investment (I), Government Spending (G), and Exports (X)<br />S + T + M <br />= <br />I + G + X or <br />OUTFLOWS <br />= <br />INFLOWS<br />OUTFLOWS: Savings (S), Taxes (T), and Imports (M)<br />

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