1. CHAPTER 1: The circular flow of the economy
The model represents all of the actors in an economy either households or firms (companies),
and it divide markets into two categories:
markets for goods and services
markets for factors of production
Concepts to be considered
Circular flow model show how the economic participants interact with one another
Market is a place where the potential buyers and potential sellers meet
Open economy is the economy that imports and exports goods and service to other
countries
Closed economy is the economy that has no foreign sector/ no international trade
Factor market- the market in which factors of production are traded
Goods markets- the market in which goods and service are traded
1.1 Circular flow of an open economy
1.1.1 Participants of an open economy
1. Household (consumers of economic goods and service)
Household own factors of production
Sell factors of production to the firms in factor market
household consume goods and service from firms in goods market
symbol C is use to indicate consumption spending by household
2. Firms (businesses or producers)
Purchase factors of production from household in the factor market
They then use factors of production to produce goods and service
Goods and services are sold to household in the goods market
1. Government(state or public sector)
Purchase factors of production from households in the factor market
Purchase goods and services from firms in goods market( symbol G denote
government spending)

2. State provide goods and services that are not produced by firms, which are
known by public goods
Government receive revenue from household and firms in the form of
taxes(symbol T denote taxes)
Also receive revenue from state-owned property and state-owned enterprises
2. Foreign sector( other countries of the world)
Trade between foreign sector and household and firms take place in the form of
imports and exports
Imports are goods and services that are produced in other countries and
purchased by local firms and household(symbol Z donate imports)
Exports are goods and services that are produced locally and then sold to other
countries(symbol X donate exports)
5. Financial sector(financial institution)
The money which household and firms provide to the financial sector is known
as savings( symbol S denote savings)
The funds collected by the financial sector are used to provide firms with the
money they need to purchase capital equipment
Spending on capital equipment by firms is known by investment(symbol I denote
investment)
1.1.2 Circular flow diagram of the economy

3. 1.1.3 Real and money flow
Households earn income from selling their factors of production to firms.
Household buy goods and services from firms and therefore a flow of goods and
services from firms to households.
Flow of money in the form of taxes from households and firms to government
Flow of goods and service whereby public goods and services are consumed by
households and firms.
Saving and investment show the flow of money between financial sector and
household and firms.
1.1.4 Leakages and injections
1. Leakages
 Represent the withdrawal of money from the local economy
 money that does not give rise to a income
 in open economy leakage are: Taxes (T)
: Expenditure on imports (Z)
: Savings(S)
2. Injection
 represent introduction of additional money into the economy
 any spending which is not derived from income
 in open economy injection are: Government spending (G)
: The revenue earned from exports
: Investment spending
1.1.5 The basic equation of this model
Aggregate spending (total spending) and aggregate income (total income)
Aggregate spending is made up on of the following concepts:
Consumption spending (C)
Investment spending by firms (I)
Government spending (G)
Spending by foreigners on SA goods (exports: X) minus spending by SA on foreign
goods (imports :Z)
In other words aggregate spending =C+I+G+X-Z
Since aggregate spending is equal to aggregate income formula is the same
Aggregate income Y = C+I+G+X-Z
Autonomous consumption(c-) and marginal propensity to consume (c)
1. Autonomous consumption(c - )= the amount of money households spend regardless
of income propensity (tendency)
2. Marginal propensity

4. 1.2 National account aggregates
Measures of economic activities
I. To determine the standard of living
II. To compare prosperity levels between countries
III. To measure economic growth from one year to the next
The used of national aggregate is the value of all goods and services produce within the
country in a given year (known as gross domestic product GDP)
GDP figures are recorded in the national accounts which are published by SARB
1.2.1 Calculating domestic production
Three ways of calculating GDP
1. production method
Calculating the sum of the value added at each stage of production process (yield
GDP at basic price).
2. income method
Calculating the income earned by the factors of production within the borders of the
country (yield GDP at basic price).
3. Expenditure method
Calculating the total expenditure on all goods and services produced within the
borders of the country (I+I+G+X-Z). (Yield GDP at basic price).
1.2.2 National account conversion
A. Distinction between tax on products and other taxes on production
Tax on production- refer to any tax that is levied per unit of the good or service
and includes value added tax (VAT), import duties, other tax on imports and tax on
exports
Other taxes on production-refer to taxes on production that are not linked to
specific good and service but include payroll taxes, business licenses and tax on
land.
B. Equation of conversion from GDP at factor cost to GDP at Basic price or GDP at
market prices
GDP at market prices= GDP at basic prices + tax on products – subsidies on
products
GDP at factor cost = GDP at basic prices – other taxes on production + other
subsidies on production
1.2.3 Domestic production versus national production

5. Gross domestic product (GDP) refer to the value of all final goods and services
that produced within the borders of a country during a given year
Gross national product refer to the value of all final goods and services produced
by the permanent residents of the country during a given year.
GDP is converted to the GNP as follows:
Gross domestic product (GDP) + primary income from the rest of the world –
primary income to ---------the rest of the world = Gross national product
1.2.4 Gross versus net domestic product (NDP)
Gross domestic product measures the value of production before provision has
been made for consumption of fixed capital
Net domestic product (NDP) is a measure of the value of production once
adjustments have been made for consumption of fixed capital.
GDP is converted to NGP as follow:
Gross domestic product – consumption of fixed capital = net domestic product
1.3 The multiplier
1.3.1 The multiplier effects
Increase in government spending lead to increase in business revenue whereby there will be
increase in income and employment which will make also increase in consumer spending
1.3.2 Derivation of the simple multiplier
Y –Cy = c- + I
Y (I –c ) =c- +I ( take out a common factor )
Y (I- c )/(I – c ) = c- + I/(I –c ) dividing both side by ( I – c )
Y = c- + I /I – c