1. THE MACROECONOMY A CIRCULAR FLOW DESCRIPTION To advance the slide Click the mouse To back up a slide Use the “up” arrow To end the show at any time Press the “Esc” button. To begin the presentation Press the button “Start Slide Show” in the lower right corner.

2. A Household A simple picture of a single household Income enters the household, mostly as the wages that the members of the household earn. Most income leaves the household as consumption. (“Consumption” is the name for household spending.) CONSUMPTION INCOMEINCOME

3. A Household It is generally true that if a household’s income increases, its consumption will also increase. CONSUMPTION INCOMEINCOME INCOMEINCOME

4. It is NOT, however, true that a household’s income will increase because it consumes more. (Try it – buy a new car and then tell your employer that you want a raise because you are spending more. It usually won’t work!) Your income comes from one place – from your work – and your consumer spending goes to a different place – to the places where you shop. A Household CONSUMPTION INCOMEINCOME

5. In Macroeconomics we won’t look at a single household. We will look at the HOUSEHOLD SECTOR Think of this as all households taken together. We will add another part of the economy. This is the PRODUCT MARKET. Think of this as all the factories and stores in the economy We now turn to MACROECONOMICS a look at the “whole” economy.

6. Now consider an interesting fact. Our income comes from the Product Market – where we work and … our spending goes to the Product Market – where we buy goods and services. We can simplify a bit and say that in macroeconomics INCOME AND SPENDING ARE THE SAME THING Your income is someone else’s spending. Your spending is someone else’s income. Taken as a whole OUR INCOME IS OUR SPENDING

7. Our simple macroeconomic diagram looks like … HOUSE- HOLDS PRODUCT MARKET INCOMEINCOME INCOME SPENDING You can see why this is called a circular flow diagram. The essential fact of a macroeconomy is that “the money goes around,”... and around, and around, and... Income becomes spending, which becomes income, which becomes … CONSUMPTIONCONSUMPTION

8. When you actually draw this by hand (and learn a lot of abbreviations) it will look something like this... You will use these diagrams a lot. You want to be able to draw them simply and quickly. In fact, once you get used to them, you can even leave off all the labels (Y, C, PrM etc.) H/B PrM Y C X

9. To repeat: The household sector is like a household because -- If your income rises, you will probably spend more. If our income rises, we will probably spend more. If your spending rises, you will not get more income. If our spending rises, we will get more income. So the household sector is not just like one large household. The circularity of macroeconomics – where spending becomes income -- does not exist for the individual household. BUT …

10. We can now add to our diagram (we can call it a “model”) more detail. We need to include … The Four Sectors 1.The Household Sector …...… 2.The Business Sector ……….. 3.The Foreign Sector ……...…. 4.The Government Sector …… * The word “investment” has a particular meaning in economics. Investment, in economics, means “the purchases by the business sector of machines, factories and inventories.” Names for their Spending 1. Consumption 2. Investment* 3. Exports and Imports** 4. Government Purchases ** Exports are what we sell to other countries. Imports are what we buy from other countries

11. GDP is broken down into the four types of spending. GD P = Total Spending = Consumption* + Investment + Exports + Government Purchase * In an unusual use of words, in this class we will typically use the word “consumption” to mean only the purchases of domestically produced goods Total Spending in the economy is measured by the most important macroeconomic statistic – Gross Domestic Product (GDP), which is defined as.. “The dollar value of all final goods and services produced in an economy in some time period (generally one year).”

12. INCOME We can add these types of spending to the model to get … HOUSE - HOLDS PRODUCT MARKET INCOMEINCOME SPENDING (GDP) CONSUMPTIONCONSUMPTION INVESTMENTINVESTMENT GOVTPURCHGOVTPURCH EXPORTSEXPORTS

13. Until now we have assumed that all of the household sector’s income is consumed, buying domestic goods. Clearly this is not true. We now describe the four uses of income. The Four Uses of Income 1.Consumption 2.Saving 3.Imports 4.Taxes

14. TAXESTAXES INCOME We can add these uses of income to the model to get … HOUSE- HOLDS PRODUCT MARKET INCOMEINCOME SPENDING (GDP) CONSUMPTIONCONSUMPTION INVESTMENTINVESTMENT GOVTPURCHGOVTPURCH EXPORTSEXPORTS SAVINGSAVING IMPORTSIMPORTS This is the OPEN MODEL See the next slide for drawing tips.

15. A hand drawing of this model looks more like this -- H/B Consumption Income Spending Exports Investment Government Purchases TaxesSavingImports PrM

16. This is the end of part 1 of the Introduction. Feel free to continue on to part 2. But maybe you ought to take a moment to stretch first.