Modeling the Economy

Actors: 1. Consumers 2. Financial Institutions 3. Businesses 4. The Government 5. The Foreign Sector

Circular Flow Model

Consumers can engage in 3 actions: 1. Consumption (C) 2. Savings (S) 3. Paying Taxes (T)

Financial Institutions SC Consumers T Government

Injection: Something that causes GDP to increase Consumption is the first of 4 possible injections

Leakages – things that, if increased, will lower GDP Two of the three leakages in the economy are: 1. Savings 2. Taxes

Financial Institutions are: 1. Banks 2. The Stock Market 3. The Bond Market

Consumers can borrow money to finance consumption (CB) ex: car loan Businesses can borrow money or sell stock in order to pay for new investment

Investment (I) is the second injection into the economy Just because money is saved doesn’t mean that it is invested

Financial stocksBusinesses Institutions bondsI CB SC Consumers T Government

The Government 1. Collects Taxes (T) – leakage 2. Spends Money (G) - injection 3. Borrows Money (GB) 4. Gives Transfer Payments to people (TP)

If the government spends more than it collects in taxes, it has a budget deficit and must borrow money A budget surplus exists when the government spends less than it collects in taxes

Financial stocksBusinesses Institutions bondsI CB SC Consumers TP T Government GB G

The Foreign Sector 1. Buys things made in the US exports (X) are the 4 th injection 2. Sells things to the US imports (IM) are the 3 rd leakage 3. Saves (FS)/ Borrows (FB)Money

If exports are greater than imports, then the US has a trade surplus If imports are greater than exports, then the US has a trade deficit

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FS Financial stocksBusinesses FB Institutions bondsI Foreign Sector CB SC X IM Consumers TP T Government GB G

Injections: 1. Consumption (C) 2. Investment (I) 3. Government Spending (G) 4. Exports (X)

Leakages: 1. Taxes (T) 2. Savings (S) 3. Imports (IM)

Every time something gets made, someone gets paid 1. labor is paid wages 2. capital is paid interest 3. land is paid rent 4. entrepreneurs are paid profit

FS Financial stocksBusinesses FB Institutions bondsI Foreign Sector CB SC X IM Consumers TP T Government Income GB wages, interest, rent, profit G