Download Income and Spending: The Circular Flow

Income and Spending: The
Circular Flow
Ways to Measure GDP
Circular Flow
Three Ways to Measure GDP
(1) The Product Approach.
GDP = Total Output of Goods and Services
(this is the definition of GDP we discussed
earlier)
(2) The Income Approach
GDP = Total Income of All Domestic
Residents
(recall Bakery Example)
Some Definitions
(i) Total Income = Wages/Salaries + Profits +
Interest + Rental
(ii) GDP = Total Value Added = Sales Revenue –
Costs for Intermediate Goods.
(iii) Profits = Sales Revenue – Costs of
Intermediate Goods – Other Costs
(iv) Other Costs = Wages/Salaries + Interest +
Rental

(iii) and (ii) says
Profits = Total Value Added – Other Costs
= GDP – Other Costs
=> GDP = Profits + Other Costs
= Profits + Wages/Salaries + Interest +
Rental
= Total Income

Other Measures of Income:
GNP = GDP + Net Income Earned Abroad
Net National Product (NNP) = GNP –
Depreciation Investment
National Income (NI) = NNP – Indirect
Business Taxes
(3) The Expenditures Approach
GDP = Total Expenditures on Final Goods
 Four Major Categories of Expenditures
(1) Consumption (C) – Household
Spending on Goods and Services
(2) Investment (I) – Business Spending on
Productive Capital Goods
(3 ) Government Purchases (G) – Government
purchases of goods and services
(4) Net Exports (NX) = Exports (X) – Imports (M)

Income-Spending Identity:
GDP =
Total Domestic Income = Total Expenditures
GDP = Y = C + I + G + NX
The Circular Flow


Four Sectors of the Economy
(1) Households
(2) Firms
(3) Government
(4) Foreigners
Capital Markets channel funds from lenders to
borrowers. Examples: Banks, Stock/Bond
Markets.

Households – Consumers/Workers (everyone)
Earns Income or GDP = Y
Spends on Consumption = C
Pays Taxes (net of transfer payments) = T
Disposable Income (DI) = Y – T
Saving (S) = DI - C


Business Firms
Produces GDP or Y = C + I + G + NX
Borrows from capital market to buy
investment goods (I).
Government
Collects Net Taxes = T
Spends on Goods and Services = G
Borrows: Federal Budget Deficit = G -T
The Federal Budget Deficit is the excess of
government spending over tax revenues or
government borrowing in a given year.
T – G > 0 => Budget Surplus
T – G < 0 => Budget Deficit
The National Debt is the total outstanding
debt of the Federal government.

Foreigners – rest of the world
Spends on U.S. Exports (X)
Sells Imports (M)
Net Exports = X – M = NX
NX > 0 => Trade Surplus (net foreign
lender)
NX < 0 => Trade Deficit (net foreign
borrower)

Some Important Relationships:
Y = C + I + G + NX
S = I + Budget Deficit + NX
= I + (G – T) + NX