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Circular Flow and Gross Domestic Product

Objective:. What is the circular flow diagram of the economy?. What is GDP and how do you calculate it?. Circular-Flow Diagram. All countries calculate a set of numbers known as the national income and product accounts. The more reliable the accounts, the more economically advanced the country is..

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Circular Flow and Gross Domestic Product






Presentation on theme: "Circular Flow and Gross Domestic Product"— Presentation transcript:

Slide1

Circular Flow and Gross Domestic ProductSlide2

Objective:

What is the circular flow diagram of the economy?

What is GDP and how do you calculate it?Slide3

Circular-Flow Diagram

All countries calculate a set of numbers known as the national income and product accounts. The more reliable the accounts, the more economically advanced the country is.

Bureau

of Economic Analysis, a division of the Department of Commerce, calculates the national accounts (national income and product accounts) to keep track of spending of consumers, sales of producers, business investment spending, government purchases, and many other flows of money amount different sectors of the economy.Slide4

Circular-Flow Diagram

The circular-flow diagram is a simplified representation of the

macroeconomy

.

Shows the flows of money, goods and services, and factors of production through the economy

Underlying principle is that the flow of money into each market or sector is equal to the flow of money coming out of that market or sectorSlide5

The Circular-Flow Diagram

Money

Factors

Goods

and

services

Factors

Households

Firms

Markets for goods and services

Factor Markets

Goods

and

services

Money

Money

MoneySlide6

Circular-Flow Diagram

The model represents the transactions that take place by two kinds of flows around a circle:

Flows of physical things such as goods; services, labor, or raw materials in one directions

Flows of money that pay for these things in the opposite directionSlide7

Circular-Flow Diagram

The simplest circular-flow diagram illustrates an economy that contains only two kinds of “inhabitants”: households and firms

Households –an individual or group of people who share their income

Firm – an organization that produces goods and services for sale and that employs members of the householdSlide8

The Circular-Flow Diagram

Money

Factors

Goods

and

services

Factors

Households

Firms

Markets for goods and services

Factor Markets

Goods

and

services

Money

Money

MoneySlide9

An Expanded Circular-Flow Diagram

Government

Firms

Markets for goods and services

Financial Markets

Households

Factor Markets

Rest of the world

Government purchases of goods and services

Government borrowing

Private savings

Government transfers

Wages, profit, interest, rent

Wages, profit, interest, rent

Borrowing and stock issues by firms

Foreign borrowing and sales of stock

Foreign lending and purchases of stock

Exports

Imports

GDP

Taxes

Consumer spendingSlide10

Expanded Circular-Flow Diagram

Consumer spending – buying goods and services from domestic firms and from firms in the rest of the world

Households also derive additional income from their indirect ownership of the physical capital used by firms – stocks

Shares in the ownership of a company

Households also receive additional income from bonds – loans to firms in the form of an IOU that pays interest

The income the household receives from factor markets includes profit distributed to company shareholders and the interest payments on any bonds that they hold

Same goes for rent from firms

In a factor market, households receive income in the form of wages, profit, interest, and rent via factor marketsSlide11

Expanded Circular-Flow Diagram

Households spend most of the income received from factors of production on goods and services

Why do the markets for goods and services don’t absorb all of a household’s income?

Households don’t get to keep all the income they receive – have to pay income and sale taxes

Some households receive government transfers – payments that the government makes to individuals without expecting a good or service in return (unemployment insurance)

Total income households have left after paying taxes and receiving government transfers is disposable incomeSlide12

Expanded Circular-Flow Diagram

Why do the markets for goods and services don’t absorb all of a household’s income

?

Many households set aside a portion of their income for private savings

The private savings go into financial markets – individuals, banks, and other institutions buy and sell stocks and bonds as well as make loansSlide13

Expanded Circular-Flow Diagram

General Characteristic of the Circular-Flow Diagram:

The total sum of flows of money out of a given box is equal to the total sum of flows of money into that boxSlide14

Circular-Flow Model: Government

Government returns a portion of the money it collects from taxes to households in the form of government transfers

Government borrowing – the amount of funds borrowed by the government in the financial markets to buy goods and services

Government purchases of goods and services are the total expenditures on goods and services by federal, state, and local governments

Includes everything from military spending on ammunitions to your local public school’s spending on chalk, erasers and teacher salariesSlide15

The World

The world participates in the U.S. economy in 3 ways:

Exports

Imports

Foreigners can participate in U.S. financial markets through foreign lending and foreign borrowing

Foreign lending is lending by foreigners to borrowers in the U.S. and purchases by foreigners of shares of stock in American companies

Foreign borrowing is borrowing by foreigners from U.S. lenders and purchases by Americans of stock in foreign companiesSlide16

Circular Flow -- Firms

Firms also buy goods and services in the economy

Building a new factory

Accumulate an inventory

Inventories are goods and raw materials that firms hold to facilitate their operations

National accounts count this as investment spending

Spending on new productive physical capital, such as machinery and buildings, and on inventories – as part of total spending on goods and services

Accounted for due to they change the ability of a firm to make future salesSlide17

Gross Domestic Product (GDP)

Final goods vs. intermediate goods

Final goods and services are goods and services sold to the final, or end, user

Intermediate goods and services are goods and services that are inputs into the production of final goods and services

The purchaser is another firm, not the final userSlide18

Gross Domestic Product (GDP)

Gross Domestic Product is the total value of all

final goods and services

produced in an economy during a given period, usually a year.

GDP of 2011 was $15,094,025

Three ways to calculate GDP:

Survey firms and add up the total value of their production of final goods and services

Add up aggregate spending on domestically produced final goods and services in the economy

GDP = C + I + G + X - IM

Sum the total factor income earned by households from firms in the economy Slide19

Gross Domestic Product (GDP)

Aggregate spending is the sum of consumer spending, investment spending, government purchases of goods and services, and exports minus importsSlide20

Calculating

GDPSlide21

Calculating GDP

$15,000

10,000

5,000

0

-5,000

Value added by government

= 11.5%

Value added by households

= 11.5%

Value added by business

= 77.1%

Consumer spending

= 70.3%

Investment spending

= 15.4%

Government purchases of goods and services

= 19.4%

Components of GDP (billions of dollars)

C + I + G

= $14,515

Net exports X – IM = –$708 (–5.1%)

Spending on domestically produced final goods and services

Value added by sectorSlide22

GDP: What’s In & What’s Out

Domestically produced final goods and services, including capital goods, new construction of structures, and changes to inventories

Intermediate goods and services

Inputs

Used goods

Financial assets – stocks and bonds

Foreign-produced goods and services

INCLUDED

NOT INCLUDED