Circular Flow Of Economic Activity

CIRCULAR FLOW OF ECONOMIC ACTIVITY

Basic Economic Activities: • Production – the use of economic resources in the creation of goods and services

• Consumption – goods and services produced are ready for use • Employment – the use of economic resources in production. • Income generation – the price paid to the resource owners either by rent, interest or labor

2 Economic Units: 2. Household - the basic consuming unit 3. Firm

- the basic producing unit

The Stock and Flow Variables Flow - a quantity measured over a particular period of time Stock - a quantity measured as of given point in time The concept of stock and flow measurements are essential in understanding the economic variables of Wealth and Income

Wealth - anything of value owned Income - is the flow and the rate of which we earn money

The Economic Model of Production The Circular Flow of the Production Process ECONOMIC RESOURCES

( Land, Labor, Capital)

HOUSEHOLDS

PRODUCING UNITS (FIRM)

GOODS AND SERVICES

Circular Flow of Goods and Services moves in clockwise

Circular Flow of Goods Among Production Units and Households 3 types of firms: 1. Raw material Firm 2. Intermediated good Firm 3. Final good Firm Interrelation between Production Units and Households

HOUSEHOLDS

Resources

Raw Material Firm

Resources

Intermediate good Firm

Resources

Final good Firm

Circular Flow of Income Income Flow of Wages, Interests, Rents

HOUSEHOLDS

PRODUCING UNITS

Purchase of Goods and Services

Circular Flow of Income is in counter clockwise. The flows of income and consumption expenditures involves financial transactions because of the payment of money.

Circular Flows of Physical Goods and Money Income Purchase of Goods and Services Economic Resources HOUSEHOLDS

PRODUCING UNITS Money Payments (Rents, Wage, Interest)

Goods And Services

The Circular Flow of Goods and Income of Households and Firms, with the Government and Foreign Countries Wages, Rents, Interest

GOVERNMENT Purchase of Goods and Services Purchase of Goods and Services Economic Resources PRODUCING UNIT

HOUSEHOLDS

Money, Payments (Rents, Wages, Interest) Goods and Services Money payments for Exports

FOREIGN COUNTRIES

Money payments for Imports

INFLOWS AND OUTFLOWS What are the Outflows in the Consumption stream?

1. Savings 2. Taxes 3. Imports

What are the Inflows in the Consumption stream?

1. Investment 2. Government spending

OUTFLOW: Savings: Households do not spend all their income for consumption. A portion of income is saved. If there are no other demand aside from that of the household, the business firm would not be able to sell their goods and services. Taxes Households have to pay the government on their income tax. When households pay taxes, the effect is lessen disposal income and lessen consumption Imports When we buy from foreign countries, the amount is spending on the part of household. But the expenditure flows into the foreign countries.

INFLOW: Investment Money deposits in the banks are used for investment on business firms and lending them to people. If investments is equal to savings, it offsets the outflow of savings. Government Spending Government uses the taxes collected from the households to defray expenses in infrastructure, social services, education and economic development. These amounts are spent back into the flow.

INFLOW: Export Income derived from export is returned back into the flow in the form of income to household and business firms and taxes to the government

Take Note:  When OUTFLOWS is taking place in the economy, recession of economic activity is bound to experience  OUTFLOWS = INFLOWS, level of economy is maintained  Excess INFLOWS over OUTFLOWS will be expansionary and results in increase in level of economic activity  Excess in OUTFLOWS over INFLOWS will make contracting effect and results in decrease economic activity

3 Sets of Policies that may be Implemented 1. MONETARY POLICY that which affects savings and investment 2. TRADE POLICY that which affects countries exports and imports 3. FISCAL POLICY that which controls taxes (revenue) and government expenditure Government applies policies in accordance with its goals. Policy may be “EASY” when the aim is for expansion. Policy may be “TIGHT” when there is a need to restrict the circular flow by making less funds available to the economy.

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Circular Flow of Income Among Production Units MONEY PAYMENTS FOR RAW MATERIALS

RAW MATERIAL FIRM

INTERMEDIATE GOOD FIRM

Money Payments For Intermediate Goods

FINAL GOOD FIRM Money Payments for Final Goods

HOUSEHOLDS