Download Circular Flow Power point

Module 10
The Circular Flow and GDP
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THE ECONOMY’S INCOME AND EXPENDITURE
When judging whether the
economy is doing well or poorly, it
is natural to look at the total income
that everyone in the economy is
earning
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What is Standard of Living?
• The configuration of arrows shown on the
first day of class represents our standard
of living
• Standard of living is an economy’s level of
prosperity; best measured by the value of
goods & services (products) produced on
average per person
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What is Standard of Living?
A nation’s standard of living is the level
of consumption of goods and services
(products) that the country’s people
enjoy, measured by average income
per person. It is the quantities and
quality of goods & services (products)
consumed that determine how well off
people are
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THE ECONOMY’S INCOME AND EXPENDITURE
For products to be consumed they must be
produced
Today, nearly ALL of the
world’s nations employ
some form of the market
system
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THE ECONOMY’S INCOME AND EXPENDITURE
• For an economy as a whole, income must
equal expenditure because:
– Every transaction has a buyer and a seller.
– Every dollar of spending by some buyer is a
dollar of income for some seller.
Income=Expenditure
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Figure 1 The Circular-Flow Diagram
Revenue
Spending
Labor, land,
and capital
Wages, rent,
and profit
= Flow of inputs
and outputs
= Flow of dollars
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THE ECONOMY’S INCOME AND EXPENDITURE
• Critical to understand the key decision
makers and the main markets present in
this system, which is governed by supply
and demand
• In the free-enterprise system, resources,
products and money payments are
exchanged among the three
interconnected decision makers in the
economy
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THE ECONOMY’S INCOME AND EXPENDITURE
• There are 3 types of decision makers in
the economy:
1. Households
2. Businesses (Firms)
3. Government
• The fourth would be the rest of the world
--In a power point soon
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Figure 1 The Circular-Flow Diagram
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
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Our First Model: The Circular-Flow Diagram
• Firms
– Produce and sell goods and services
– Hire and use factors of production
– On the supply side of the markets
• Households
– Buy and consume goods and services
– Own and sell factors of production
– On the demand side of the markets
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Our First Model: The Circular-Flow Diagram
• Markets for Goods and Services
– Firms sell
– Households buy
• Markets for Factors of Production
– Households sell
– Firms buy
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Our First Model: The Circular-Flow Diagram
• Factors of Production
– Inputs used to produce goods and services
– Land, labor, and capital
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Our First Model: The Circular-Flow Diagram
• Interaction of this demand and supply
determines the price of each product
• Flow of consumers expenditures
constitutes sales receipts for businesses
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CIRCULAR FLOW QUESTIONS-1
• What is household?
• CONSUMERS/RESOURCE OWNERS
• CONSUMERS
– play a leading role in the economy
– demand the products produced
• Resource owner
– Supply the resources used to produce the
products
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CIRCULAR FLOW QUESTIONS-2
• What is business/firm?
– play a leading role in the economy
– demands the resources that households
supply
– Utilize these resources to supply the products
that households purchase
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CIRCULAR FLOW QUESTIONS-2
• What is government?
– play a leading role in the economy
– demands the resources that households
supply
– Utilize these resources to supply the products
that households use
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CIRCULAR FLOW QUESTIONS-1
• What is a product market?
• is the place where goods and services
(G/S) are exchanged.
• An example would be a retail clothing
store.
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CIRCULAR FLOW QUESTIONS-2
• Give two examples of transactions that
you made in the product market within the
last week.
• Food at Wegmans
• Gas at Raceway
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CIRCULAR FLOW QUESTIONS-3
• What is the factor market?
• the place where resources are used to
produce products that are exchanged. The
three components of the factor market are
land, labor and capital, (and entrepreneur)
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CIRCULAR FLOW QUESTIONS-4
• Give examples of the factor markets.
• Land purchased by a firm to build a new
factory
• Labor purchased by a firm to build
products
• Purchase machines to produce the
product
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CIRCULAR FLOW QUESTIONS-5
• Explain how the circular flow model
reflects interdependence.
• the arrows represent how all components
of the economy rely on each other.
• IF one component falters, it has a ripple
effect on the economy.
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CIRCULAR FLOW QUESTIONS-6
• Where do households get the money to
buy goods in the product market?
• Households get the money to buy goods in
the product market by providing labor in
the input markets.
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CIRCULAR FLOW QUESTIONS-7
• Where do firms get the money to buy raw
materials in the factor markets?
• Firms get the money to buy raw materials in the
factors markets by providing G/S for sale in the
product markets for households to purchase.
• A commercial bank acts as an intermediary, linking
savers and borrowers so that borrowers can
acquire the funds to get the needed resources.
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CIRCULAR FLOW QUESTIONS-8
• What determines the price that consumers
will pay for a good in the product market?
• The price is set by the demand for a good
as determined by the marketplace.
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CIRCULAR FLOW QUESTIONS-9
• What determines the price that firms will
pay for labor in the factor market?
• The price is set by the demand for labor as
determined by the marketplace.
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GDP and Its Components (2004)
(expanded in the next ppt)
Government Purchases
15%
Net Exports
Investment
-5 %
16%
Consumption
70%
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REAL VERSUS NOMINAL GDP
• Nominal GDP values the production of
goods and services at current prices.
• Real GDP values the production of goods
and services at constant prices.
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REAL VERSUS NOMINAL GDP
• An accurate view of the economy requires
adjusting nominal to real GDP by using the
GDP deflator.
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Table 2 Real and Nominal GDP
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Table 2 Real and Nominal GDP
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Table 2 Real and Nominal GDP
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The GDP Deflator
• The GDP deflator is a measure of the price
level calculated as the ratio of nominal GDP to
real GDP times 100.
• It tells us what portion of the rise in nominal
GDP that is attributable to a rise in prices rather
than a rise in the quantities produced.
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The GDP Deflator
• The GDP deflator is calculated as follows:
Nominal GDP
GDP deflator =
 100
Real GDP
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The GDP Deflator
• Nominal GDP is converted to real GDP as
follows:
Real GDP20XX
Nominal GDP20XX

 100
GDP deflator20XX
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Table 2 Real and Nominal GDP
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Figure 2 Real GDP in the United States
Billions of
2000 Dollars
$10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1970
1975
1980
1985
1990
1995
2000
2005
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IS GDP A GOOD MEASURE OF ECONOMIC WELLBEING?
• GDP is the best single measure of the
economic well-being of a society.
• GDP per person tells us the income and
expenditure of the average person in the
economy.
• Higher GDP per person indicates a higher
standard of living.
• GDP is not a perfect measure of the
happiness or quality of life, however.
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GDP AND ECONOMIC
WELL-BEING
• Some things that contribute to well-being
are not included in GDP.
– The value of leisure.
– The value of a clean environment.
– The value of almost all activity that takes
place outside of markets, such as the value of
the time parents spend with their children and
the value of volunteer work.
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Table 3 GDP and the Quality of Life
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Summary
• Because every transaction has a buyer and a
seller, the total expenditure in the economy
must equal the total income in the economy.
• Gross domestic product (GDP) measures an
economy’s total expenditure on newly
produced goods and services and the total
income earned from the production of these
goods and services.
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Summary
• GDP is the market value of all final goods and
services produced within a country in a given
period of time.
• GDP is divided among four components of
expenditure: consumption, investment,
government purchases, and net exports.
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Summary
• Nominal GDP uses current prices to value the
economy’s production. Real GDP uses
constant base-year prices to value the
economy’s production of goods and services.
• The GDP deflator—calculated from the ratio
of nominal to real GDP—measures the level of
prices in the economy.
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Summary
• GDP is a good measure of economic wellbeing because people prefer higher to lower
incomes.
• It is not a perfect measure of well-being
because some things, such as leisure time and
a clean environment, are not measured by
GDP.
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