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CHAPTER Analysis of the Financial System and the Economy Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. 4 Financial Statement of J. P. Young, January 1, 2002 through December 31, 2002 Expenditures (Uses) Consumption (spending on goods and services) Saving (acquisition of summer home) (acquisition of financial claims) Consumption plus saving Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Receipts (Sources) $44,000 $ 8,000 $ 5,000 $ 3,000 $52,000 Wages and salaries Dividends $47,000 $ 3,000 Interest Rent Disposable income $ 2,000 $ 0 $52,000 Financial Statement of All Purpose Enterprise Inc., January 1, 2002 through December 2002 (in Millions of Dollars) (A) Total expenses Wages and salaries Interest on debt Cost of raw materials purchased from other firms $ 5,400 5,700 200 (B) Net income (sales – expenses) minus dividends equals retained earnings $ 500 300 $ 200 (C) Business investment spending Financing: (new capital goods– plant and equipment—and/or additions to inventories $ 500 Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Total sales $5,900 500 Financing: New bonds issued Retained earnings $300 200 $500 National Income and Expenditures for Our Hypothetical Economy, 2001 (in Billions of Dollars) Sector Income Expenditures Households Disposable personal income $5,200 Consumption expenditures Investment expenditures Business firms Retained earnings $200 Investment expenditures Economy National income $5,400 Domestic product Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Income – Expenditures = Deficit or Surplus $4,400 $500 $500 $5,400 Surplus $300 Deficit - $300 The Circular Flow Diagram Money Flows from Households to Firms to Pay for Goods and Services PRODUCT MARKETS Products Flow from Firms to Households AS Price Index AD Real GDP Surplus Funds Flow from SSUs to DSUs HOUSEHOLDS FINANCIAL MARKETS Supply Interest Rate Demand Loanable Funds Supply Wages Demand Labor Labor and Other Factors Flow from Households to Firms FACTOR MARKETS Factor Payments (Wages, etc.) Flow from Firms to Households Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. FIRMS The Product Market: Aggregate Demand and Aggregate Supply. Price Index AS 1.0 A AD $5,400 Real GDP (in Billions) Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. The Factor Market: The Demand for and Supply of Labor Wage Rate/ Hour S $23.50 B D 200 Labor Hours (in Billions) Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. The Financial System: The Demand for and Supply of Loanable Funds Interest Rate (Percent) S 4 C D $300 Loanable Funds (in Billions) Copyright © 2003 by South-Western/Thomson Learning. All rights reserved. Goals of Various Spending Units Households Maximize Utility (Satisfaction) Firms Maximize Profits Copyright © 2003 by South-Western/Thomson Learning. All rights reserved.