Download Circular Flow Model

Modeling the Economy
Actors:
1. Consumers
2. Financial Institutions
3. Businesses
4. The Government
5. The Foreign Sector
Circular Flow Model
Consumers can engage in 3
actions:
1. Consumption (C)
2. Savings (S)
3. Paying Taxes (T)
Financial
Institutions
S
C
Consumers
T
Government
Injection: Something that
causes GDP to increase
Consumption is the first of 4
possible injections
Leakages – things that, if
increased, will lower GDP
Two of the three leakages in the
economy are:
1. Savings
2. Taxes
Financial Institutions are:
1. Banks
2. The Stock Market
3. The Bond Market
Consumers can borrow money
to finance consumption (CB)
ex: car loan
Businesses can borrow money
or sell stock in order to pay for
new investment
Investment (I) is the second
injection into the economy
Just because money is saved
doesn’t mean that it is invested
Financial stocksBusinesses
Institutions bonds
I
CB S
C
Consumers
T
Government
The Government
1. Collects Taxes (T) – leakage
2. Spends Money (G) - injection
3. Borrows Money (GB)
4. Gives Transfer Payments
to people (TP)
If the government spends more
than it collects in taxes, it has a
budget deficit and must borrow
money
A budget surplus exists when
the government spends less
than it collects in taxes
Financial stocksBusinesses
Institutions bonds
I
CB S
C
Consumers
TP T
Government
GB
G
The Foreign Sector
1. Buys things made in the US
exports (X) are the 4th injection
2. Sells things to the US
imports (IM) are the 3rd leakage
3. Saves (FS)/ Borrows (FB)Money
If exports are greater than
imports, then the US has a
trade surplus
If imports are greater than
exports, then the US has a
trade deficit
http://www.census.gov/indicator/
www/ustrade.html
FS
Financial stocksBusinesses FB
Institutions bonds
I
Foreign
Sector
CB S C
X IM
Consumers
TP T
Government
GB
G
Injections:
1. Consumption (C)
2. Investment (I)
3. Government Spending (G)
4. Exports (X)
Leakages:
1. Taxes (T)
2. Savings (S)
3. Imports (IM)
Every time something gets
made, someone gets paid
1. labor is paid wages
2. capital is paid interest
3. land is paid rent
4. entrepreneurs are paid profit
FS
Financial stocksBusinesses FB
Institutions bonds
I
Foreign
Sector
CB S C
X IM
Consumers
TP T
Government
Income
GB
wages, interest, rent, profit
G