1. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-1 PART 7 THE CIRCULAR FLOW AND ECONOMIC FLUCTUATIONS Chapter 15 The Circular Flow

2. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-2 Lecture Plan The exchange flow between households and the business sector – The two-sector economy The exchange flows with financial markets – The financial sector and the three-sector economy The exchange flows between households, businesses and government – The government sector and the four-sector economy Exchange flows with other countries – The overseas sector and the five-sector (open) economy

3. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-3 The Circular Flow of Goods and Money In a capitalistic/mixed economy money is used to – Buy and sell goods and resources in markets – Pay and collect taxes – Borrow and lend in financial markets The ABS structures the Australian national accounts around the five sectors of the economy i.e. – Businesses, households – Financial, government, overseas sectors

4. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-4 The Two-sector Model of the Economy (Households and Firms) The households (consumers): – Require goods and services to satisfy their personal wants – Own all resources (i.e. labour, capital, land, enterprise) – Sell resources to businesses – Gain income (e.g. wage, interest, rent, profit) from such sales The firms/business sector (producers): – Uses resources provided by households to produce goods and services – Sells those goods and services for income

5. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-5 The Two-sector Model of the Economy Assumptions: – Businesses are the only producers – All goods and services are sold to consumers – Consumers spend ALL their income on goods and services – There are no resource inventories Therefore: Total demand (expenditure) = total supply (output) The economy will always be in equilibrium (cont.)

6. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-6 The Two-sector Model of the Economy (cont.) Two groups of decision makers – Households (sell their resources) – Firms (sell goods and services) Interaction between the two sectors through markets: – Resource (factor) markets – Product markets (cont.)

7. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-7 Productive resources Income Expenditure Goods and Services Household sector Product market Firms sector Factor market The Two-sector Model of the Economy (cont.)

8. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-8 In the Basic Circular Flow O = Y = E Where: O = output (production) Y = income E = expenditure (demand)

9. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-9 The Financial Sector Saving (S) = Part of the Income that is not spent (leakage) Total income = consumption spending + saving, i.e. Y = C + S Investment (I) = that part of production that is not used for current consumption, e.g. capital goods Total income (Y) = C + I Investment is an injection. If: S > I, the economy contracts S < I, the economy expands S = I, the economy is in equilibrium The financial sector acts as an intermediary between lenders and borrowers

10. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-10 The Government Sector Government taxation (T) reduces households’ disposable income and business funds Taxation (T) is a leakage (outflow) Government spending (G) includes expenditure on collective goods and services and goods and services provided by the business sector, plus transfer payments (social security payments)

11. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-11 The Modified Five-sector Model of the Economy It is a five-sector model of the economy: The household sector T he firms sector The government sector The financial sector The external (overseas) sector

12. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-12 Household sector Financial sector Government sector External sector Firms sector Imports Savings Government expenditure Exports Taxation Investment INJECTIONSINJECTIONSINJECTIONSINJECTIONS LEAKAGESLEAKAGESLEAKAGESLEAKAGES Expenditure Income The Two-sector Model of the Economy (cont.)

13. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-13 The Open Economy Total leakages (outflows) are S, T and M Total injections are I, G and X The impact of total leakages/injections on the economic activity is as follows: S + T + M = I + G + X equilibrium S + T + M > I + G + X contraction S + T + M < I + G + X expansion