The Circular Flow of Economic Activity

1. THE CIRCULAR FLOW OF
ECONOMIC ACTIVITY
INTRODUCTORY MACROECONOMICS
By: Cristobal M. Pagoso
Rosemary P. Dinio
George A. Villasis
Prepared by:
GREGAR DONAVEN E. VALDEHUEZA, MBA
Lourdes College Instructor

2. Basic Economic Activities
 Production
• The use of economic resources in the creation of goods and
services for the satisfaction of human wants.
 Consumption
• The using up of goods and services by consumer purchasing
or in the production of other goods.
 Employment
• The use of economic resources in production; engagement
in activity
 Income Generation
• The production of maximum amount an individual can spend
during a period without being any worse off.

3. Two Economic Units
 Household
• The basic consuming unit.
 Firm
• The basic producing unit.

4. Stock and Flow Variables
 Flow
• A quantity measured over a particular period of time.
 Stock
• A quantity measured as of a given point in time.
The concepts of stock and flow measurements
are essential in understanding the economic
variables of wealth and income.
 Wealth
• Anything of valued owned. It is a stock since it is what is
owned at a particular time.
 Income
• The rate at which we earn money. It is a flow since income
that is saved, increases the stock of wealth.

5. Economic Model of Production
The Circular Flow of the Production Process
ECONOMIC
RESOURCES
HOUSEHOLDS PRODUCING UNITS
GOODS AND
SERVICES

6. Circular Flow of Goods Among Production Units
RAW
MATERIALS
RAW MATERIAL FIRM INTERMEDIATE GOOD
FIRM
CONSUMERS
INTERMEDIATE
GOODS
FINAL GOODS
FINAL GOOD FIRM

7. Interrelation Between
Production Units & Households
RAW MATERIAL FIRM
RESOURCES
INTERMEDIATE
HOUSEHOLDS RESOURCES
GOOD FIRM
RESOURCES FINAL GOOD FIRM

8. Economic Model of Income and Consumption
The Circular Flow of Goods and Income
Among Producers & Households
RESOURCES RAW MATERIAL
FIRM
MONEY PAYMENT FOR RERESOURCES
RESOURCES
MONEY PAYMENT FOR RESOURCES
HOUSEHOLDS INTERMEDIATE
GOOD FIRM
RESOURCES
MONEY PAYMENT FOR RESOURCES
MONEY PAYMENT FOR PURCHASE OF FINAL
GOODS
FINAL GOOD FIRM
FINAL GOODS

9. The Circular Flow of Income
INCOME FLOW OF WAGES,
INTERESTS, RENTS
HOUSEHOLDS PRODUCING UNITS
PURCHASES OF GOODS AND
SERVICES

10. Circular Flow of Income Among Production Units
MONEY PAYMENTS FOR
RAW MATERIALS
RAW MATERIALS INTERMEDIATE
FIRM GOOD FIRM
MONEY PAYMENTS FOR
INTERMEDIATE GOODS
FINAL GOOD
FIRM
MONEY PAYMENTS FOR
HOUSEHOLDS
FINAL GOODS

11. The Circular Flow of Output and Income
Circular Flow of Physical Goods and Money Income
Goods and Services
Factors of Production
(land, labor, capital, entrepreneur)
Household Business
Sector Sector
Payments of Factors
(rent, wages, interest, profit)
Payment of Purchase
of goods and services.

12. The Circular Flow of
Goods & Income of Households & Firms
with the Government & Foreign Countries
GOVERNMENT
Wages, Transfer Payments Purchase of Goods
& Services
Taxes Taxes
Economic Resources
Purchase of Goods & Services
HOUSEHOLDS PRODUCING UNITS
Income Payments of Wages, Rent,
Dividends, & Interests
Goods & Services
Money Payments for Money Payments for
Imports Exports
FOREIGN COUNTRIES

13. Implications of the
Circular Flow of Economic Activity
 The goods, resources, and money payments
will flow as long as households continue to
consume, and as long as firms continue to
produce.
 That since goods and resources flow in
exchange for payments, the rate of
payments flow will in the end be the same.
Money is the inducing factor, and the pillar of
the price system. Without it, there is no price
system.

14. Inflows and Outflows
 Outflows (factors that decrease the
level of economic activity)
• Savings
• Taxes
• Imports
 Inflows (factors that increase the level
of economic activity)
• Investment
• Government Spending
• Exports

15. The Circular Flow of Economic Activity
Reflecting The Outflows & The Inflows
Economic Resources
Purchase of Goods & Services
HOUSEHOLDS PRODUCING UNITS
Income Payments of Wages, Rent,
Dividends, & Interests
Goods & Services
IMPORTS Foreign Countries EXPORTS
TAXES Government EXPENDITURES
SAVINGS Banks INVESTMENTS

16. Outflows are difficult to control because
they are dependent on income. When
income increases, we expect savings,
taxes, and imports to increase.
Inflows are easier to manipulate. The
proper use of policy enables the
government to encourage exports and
investments and to increase its
expenditures when it desires to expand
the flow of economic activity.

17. Three Sets of Policy
 Monetary policy
• Affects the savings and investment.
 Fiscal policy
• Controls taxes and government expenditures.
 Trade policy
• Affects a country’s exports and imports.

18. - THE END -
Any questions?
GOOD DAY!!! 