Circular Flow Of Income.pdf 6s5w2

THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

Basic Economic Activities • Production • The use of economic resources in the creation of goods and services for the satisfaction of human wants.

• Consumption • The u 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.

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

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.

Economic Model of Production The Circular Flow of the Production Process ECONOMIC RESOURCES

HOUSEHOLDS

PRODUCING UNITS

GOODS AND SERVICES

Circular Flow of Goods Among Production Units RAW MATERIALS

INTERMEDIATE GOOD FIRM

RAW MATERIAL FIRM

CONSUMERS INTERMEDIATE GOODS

FINAL GOODS

FINAL GOOD FIRM

Interrelation Between Production Units & Households RESOURCES

HOUSEHOLDS

RAW MATERIAL FIRM

RESOURCES

INTERMEDIATE GOOD FIRM

RESOURCES

FINAL GOOD FIRM

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 GOODS

FINAL GOOD FIRM

The Circular Flow of Income INCOME FLOW OF WAGES, INTERESTS, RENTS

HOUSEHOLDS

PRODUCING UNITS

PURCHASES OF GOODS AND SERVICES

Circular Flow of Income Among Production Units MONEY PAYMENTS FOR RAW MATERIALS

RAW MATERIALS FIRM

INTERMEDIATE GOOD FIRM MONEY PAYMENTS FOR INTERMEDIATE GOODS

FINAL GOOD FIRM

MONEY PAYMENTS FOR FINAL GOODS

HOUSEHOLDS

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 Sector

Business Sector

Payments of Factors (rent, wages, interest, profit) Payment of Purchase of goods and services.

The Circular Flow of Goods & Income of Households & Firms with the Government & Foreign Countries GOVERNMENT

Wages, Transfer Payments Taxes

Purchase of Goods & Services Taxes

Economic Resources

Purchase of Goods & Services HOUSEHOLDS

PRODUCING UNITS Income Payments of Wages, Rent, Dividends, & Interests

Goods & Services Money Payments for Imports

Money Payments for Exports FOREIGN COUNTRIES

Implications of the Circular Flow of Economic Activity 1. The goods, resources, and money payments will flow as long as households continue to consume, and as long as firms continue to produce. 2. 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.

Inflows and Outflows • Outflows Withdrawals (factors that decrease the level of economic activity) • Savings • Taxes • Imports

• Inflows Injections (factors that increase the level of economic activity) • Investment • Government Spending • Exports

The Circular Flow of Economic Activity Reflecting The Outflows & The Inflows Economic Resources

HOUSEHOLDS

Purchase of Goods & Services

PRODUCING UNITS

Income Payments of Wages, Rent, Dividends, & Interests

Goods & Services IMPORTS

Foreign Countries

EXPORTS

TAXES

Government

EXPENDITURES

SAVINGS

Banks

INVESTMENTS

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.

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.