The Circular Flow of Income

Assuming economy consist of two sector: FIRMS (suppliers of goods and services, demanders of factor services) HOUSEHOLDS (demanders of goods and services, suppliers of factor services) Firms: Suppliers of goods and services, and demanders of factor services. For example the taiwan beer company supplies taiwan beer therefore they need to hire a bunch of workers to help run the factory. Households, this is us lot the demanders of goods and services, for example an irony, construction workers have the demands of house to stay they are also wanted by companies that builds house

Logic: The circular flow of income Firms Factor payments Consumption of domestically produced goods and services By Assuming the basic of the circular flow of income with only two sector and without the interference of overseas sector, government sector and financial sector. The circular flow of income should look like this. Factor payments- Payments made to scarce resources, or the factors of production (labor, capital, land, and entrepreneurship), in return for productive services. In this case it is the wages paid to the construction workers Households

The interdependence of goods and factor markets demand Producer supply £ £ Factor services Goods P P D2 S S D2 D1 D1 PF2 P2 QF2 PF1 P1 Q2 QF1 Q1 O Factor services Q Goods O Q £ £ Factor supply Consumer demand fig

Circular Flow Between Firms and Households (real resources) Goods and services Households Firms FOP Input: Household includes workers, managers, entrepreneurs etc.

Circular Flow Between Firms and Households (corresponding flow of payments) Spending on goods and services Households Firms FOP incomes

Circular Flow Between Firms and Households Expenditure Goods and services 3 ways of measuring the economic activity in the economy Households Firms Services of productive factors Factor incomes

Three measures of national output Expenditure Income Output Expenditure the sum of expenditures in the economy,Money spent by an individual, business or government for any purpose. Income the sum of incomes all factor incomes : Factor incomes comprises compensation of employees by, and operating surplus of, producers. Output the sum of output (value added) produced in the economy All three approaches are should give you the same final figure for national output The total value of goods and services produced by an economy in a specified time period. Also known as GDP GDP - Value of all goods and services produced in a country in one year.

Gross domestic product (GDP) Measuring Output Total value added Gross domestic product (GDP) Total value added is the economy’s net output after deducting goods used during production to avoid double counting E.g. egg, milk, flour used for making muffins. MUFFINS. Final Good. Gross domestic product (GDP) measures the output produced by factors of production located in the domestic economy over a period of time, usually a year Value of all goods and services produced in a country in one year.

Circular Flow Between Firms and Households Spending on goods and services Leakages Households Firms Factor incomes

Leakages from the Circular Flow Leakages - money paid to the households but not returned to firm Or flow of payments that started from firms but did not return back to firms e.g. household savings, net taxes and imports

Circular Flow Between Firms and Households Spending on goods and services Injections Households Firms Factor incomes

Injections into the Circular Flow Injections - are revenue for firms not from sales to household e.g. investment by firms, government purchases and exports

The Circular Flow of Income with Government and Foreign Trade Goods & Services (G) Transfer Payments (B) Taxes (T) Foreign Sector:: Export (X) Import (M) Government spends money on goods & services (G) finances welfare payments, i.e. transfer payments (B) this spending is financed by taxes (T) Foreign Sector: Export (X) made at local economy but sold abroad. Taiwan beer selling in China is export of goods lol Import (M) made abroad and bought at local economy. Scottish whisky is an example of Import goods

The Circular Flow of Income in Symbols Domestic Output (GDP) is either: Consumed (C) Invested (I) Bought by the Government (G) Bought by the foreigners, net exports (X-M) Factor Incomes are spent on: Consumption (C) Saving (S) Paying taxes net of benefits (T-B) Domestic Output (GDP) is either Consumed (C) Invested (I) (INCREASE IN STOCK OF CAPITAL) Bought by the Government (G) Bought by the foreigners, net exports (X-M) Factor Incomes are spent on Consumption (C) Saving (S) Paying taxes net of benefits (T-B)

The Circular Flow of Income in Symbols GDP = C + I + G + (X – M) Factor Income = C + S + (T – B) Domestic Output (GDP) = Factor Incomes Since every things produced in the economy generates equivalent factor income

The Circular Flow of Income in Symbols Domestic Output Factor Incomes C + I + G + (X – M) = C + S + (T – B) C: Consumption I: Investment G: Government Expenditure X-M: Net exports C: Consumed S: Savings T-B: Taxes Net of Benefits

The Circular Flow of Income in Symbols Domestic Output Factor Incomes C + I + G + (X – M) = C + S + (T – B) I + G + X S + (T – B) + M = Total Injections Total Leakages

Figure: Showing how a Circular Flow of Income function (sources from Wikipedia)

Useful Resources: http://en.wikipedia.org/wiki/Circular_flow_of_in come

THE END (: Rebecca & Dawgen