The document describes the circular flow of economic activity through different economic models. The basic 2-sector circular flow model shows the reciprocal relationship between households and firms, with households supplying factors of production and buying goods/services, and firms using factors of production and selling goods/services. A 5-sector model adds the financial, government, and international sectors and considers injections and leakages that impact equilibrium. The models demonstrate how income and spending circulate through an economy at both the micro and macro levels.

1. The Circular Flow of Economic Activity

2. Review of Microeconomic Activities:Markets for factors (inputs) of productionMarkets for goods and servicesBuyersMarkets for goods and servicesMarkets for factors (inputs) of productionSellers

3. Review of Microeconomic Activities:Optimal satisfactionAsBuyersMinimal CostMaximum IncomeProfit MaximizationAsSellers

4. Review of Microeconomic Activities:Consumer SurplusProducer SurplusSurplus

5. From Microeconomic Analysis to Macroeconomic Analysis:First, analysis of markets (microeconomics)Next, analysis of economic sectors (macroeconomics):2-Sector Circular Flow (basic sectors directly connected to the markets; basic economy)5-Sector Circular Flow (3 additional sectors to complete the economy)

6. The Basic (2-Sector) Circular Flow Modela simple economic model which describes the reciprocal circulation of income between producers and consumers.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. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households.

7. MARKETSFORGOODS AND SERVICESFirms sellGoods andGoodsHouseholds buyservicesand servicesboughtsoldHOUSEHOLDSFIRMSBuy and consume

8. Produce and sellgoods and servicesgoods and servicesOwn and sell factors

9. Hire and use factorsof productionof productionMARKETSLabor, land,Factors ofFORand capitalproductionFACTORS OF PRODUCTIONHouseholds sellWages, rent,Firms buyand profitThe Basic 2-Sector Circular Flow Model (w/ details)SpendingRevenueIncome= Flow of inputs and outputs= Flow of moneyCopyright © 2004 South-Western

10. The Basic (2-Sector Circular Flow Model

11. The Basic (2-Sector Circular Flow ModelAssumptions: (ideal situation)The economy consists of two sectors: households and firms.Households spend all of their income (Y) on goods and services or consumption (C). There is no saving (S).All output (O) produced by firms is purchased by households through their expenditure (E).There is no financial sector.There is no government sector.There is no international sector.

12. The Basic Circular Flow ModelThe Simple Maths:Y = EE = CC = O/.: Income Perspective: Y = C

13. The 5-Sector ModelA more realistic representation of the economy.Unlike the two sector model where there are six assumptions the five sector circular flow relaxes all six assumptions. Since the first assumption is relaxed there are three more sectors introduced.

14. The 5-Sector ModelThe Three Additional Sectors:The Financial Sector The Government SectorThe International (or Overseas) Sector

15. The 5-Sector ModelIncome (Y)ResourcesHOUSEHOLDSFIRMSOutput (O)Consumption/Expenditures (E)INJECTIONSL E A K A G E SSavings (S)Investments (I)FINANCIAL SECTORGovernment Spending (G)Taxation (T)GOVERNMENT SECTORImports (M)Exports (X)INTERNATIONAL SECTOR

16. The 5-Sector ModelLEAKAGESSavings (S)Taxes (T)Imports (M)INJECTIONSFINANCIAL SECTORInvestments (I)Government Spending (G)Exports (X)GOVERNMENT SECTORINTERNATIONAL SECTOR

17. The Basic Circular Flow ModelThe Simple Maths:Since Y = C + S + T + M Y= C + I + G + XThen, S + T + M = I + G + X(Leakages) (Injections)

18. The Basic Circular Flow ModelIf:S + T + M = I + G + XS + T + M > I + G + XS + T + M < I + G + XThen, we have a:More or less Stable Economy.Contracting or Shrinking Economy.Growing economy.