Download Circular Flow

Circular Flow
Gemma Kotula
Christopher Newport University
1
Center for Economic Education
Lets look at some definitions
Market – any place where buyers and sellers come together
Revenue – money earned from the sale of goods & services
Interest – additional money owed when taking out a loan
Wages – money paid for labor (workers)
Income – money earned by performing labor (working)
Rent – money paid for the use of land or property
2
Businesses
Households
2 Decision Makers
3
Product Market
Market for
Goods & Services
Businesses
Households
2 Decision
Makers
2 Markets
Resource Market
(Factor Market)
Market for
Factors of Production
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Product Market
Spending
$
Market for
Goods & Services
$
Goods and
Services
Bought by
Consumers
Businesses
$
Households
Flow of Dollars
Flow of Goods and Services
Resource Market
(Factor Market)
Market for
Factors of Production
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Revenue
$
Spending
$
Market for
Goods & Services
$
$
Product Market
Goods and
Services
Bought by
Consumers
Goods and
Services Sold
By Firms
Businesses
$
$
Households
Flow of Dollars
Flow of Goods and Services
Resource Market
(Factor Market)
Market for
Factors of Production
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Revenue
$
$
$
Product Market
Spending
$
Market for
Goods & Services
Goods and
Services Sold
By Firms
Goods and
Services
Bought by
Consumers
Businesses
$
$
Households
Decision Makers
Markets
$
Land, Labor,
Capital,
Entrepreneurship
and Technology
Flow of Dollars
Flow of Goods and Services
Flow of Factors of Production
$
Resource Market
$
(Factor Market)
Market for
Factors of Production
Wages, Rents, and
Interest
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Revenue
$
$
$
Product Market
Spending
$
Market for
Goods & Services
Goods and
Services Sold
By Firms
Goods and
Services
Bought by
Consumers
Businesses
$
$
Households
Decision Makers
Markets
$
Land, Labor,
Capital,
Entrepreneurship
and Technology
Flow of Dollars
Flow of Goods and Services
Flow of Factors of Production
$
Resource Market
$
(Factor Market)
Market for
Factors of Production
Wages, Rents, and
Interest
Land, Labor,
Capital,
Entrepreneurship
and Technology
$
$
$
Income
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Even though we have
worked quadrant to quadrant
we now have a complete…
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Revenue
Product Market
Spending
Market for
Goods & Services
$
$
$
$
$
$
Businesses
Decision Makers
Markets
Households
Flow of Dollars
$
$
$
Resource Market
$
$
(Factor Market)
$
Market for
Factors of Production
Wages, Rents, and
Interest
Income
10
Even though we have
worked quadrant to quadrant
we now have a complete…
11
Product Market
Market for
Goods & Services
Goods and
Services
Bought By
Goods and
Services Sold
By Firms
Consumers
Businesses
Decision Makers
Markets
Households
Flow of Goods and Services &
Flow of Factors of Production
Land, Labor,
Capital,
Entrepreneurship
& Technology
Resource Market
Land, Labor,
Capital,
Entrepreneurship
& Technology
(Factor Market)
Market for
Factors of Production
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• Putting all flows together shows us that
they are indeed circular.
• Therefore the dollars that flow around
counterclockwise (in this example) are
equal to…
• The goods, services, and factors of
production that flow around clockwise (in
this example).
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Revenue
Spending
Product Market
Market for
Goods & Services
$
$
$
$
Goods and
Services
Bought By
Goods and
Services Sold
By Firms
$
$
Consumers
Businesses
$
$
Land, Labor,
Capital,
Entrepreneurship
& Technology
Decision Makers
Markets
Flow of Dollars
Flow of Goods and Services &
Flow of Factors of Production
Resource Market
Households
Land, Labor,
Capital,
Entrepreneurship
& Technology
(Factor Market)
$
Wages, Rents, and
Interest
$
$
$
Market for
Factors of Production
Income
14
Does the Circular Flow Leak?
• Classical economists were guided by
Say’s Law.
• In a simple economy Say’s Law states that
by producing goods and services, firms
create a total demand for goods and
services equal to what they have
produced.
• Or more simply, supply creates its own
demand. So yes there may be leaks!
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But it also gets “pumped up”!
• Households don’t spend all of their income. Rather,
some of their income goes to savings (leakage) or to pay
taxes (leakage).
• Households are not the only spenders in the economy.
Rather, firms also spend money on capital goods
(injection) and the government also spends money on
final goods and services (injection).
• In addition to markets for goods and markets for
resources, there is also a loanable funds market where
household saving is made available to firms and the
government.
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• Total spending in the circular flow will
equal total output in the circular flow if
and only if leakages in the economy are
equal to total injections.
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Total Spending
=
Total Output
Or… what goes around comes around!
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Government has a role in the
economy…
• However, the government’s role in the
economy is dependent on the taxes it
charges (and firms and households pay).
• And that role includes providing goods and
services to those same firms and
housholds!
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Spending
Revenue
Product Market
$
$
$
Market for
Goods & Services
$
Government
Provides goods and services to
Households
and receives taxes in return
$
Businesses
$
Households
Government
Provides goods and services
to Firms
and receives taxes in return
$
$
$
$
$
$
Resource Market
(Factor Market)
Wages, Rents, and
Interest
Market for
Factors of Production
Income
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