25-The Circular Flow of Income

8/11/2019 25-The Circular Flow of Income

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Unit 2: The National Economy

Managing the Economy


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A key macroeconomic variable is the level ofoutput in an economy, often called NATIONALINCOME.

Simple model of economy: Closed Economy- there is no foreign trade in the

economy.

Open Economy- there is foreign trade in the

economy.


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The main four categories of expenditure:

1. Consumption (C)- Household spending on consumer goods2. Investment (I)- Spending by firm and household on new capital

(plant, equipment, inventory etc)

3. Government spending (G)- spending by government

4. Net export, Xn (X-M)

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GDP = C + I + G +Xn

Add up all the spending in final goods and services that are take placethroughout the year.


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Wages- paid by business and government to the employees

Rents- income received by households and businesses thatsupply property resources > monthly rental, lease.

Interest- the money paid by private businesses to the supplier of

money capital. Includes interest income for HH from savingdeposits, corporate bonds, certificates of deposits (CDs).

Profits- proprietors income and corporate profits

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o Income to those who are responsible for producing the output.

o In a simple say, we could say that the entire amount flowed backto them in the form of wages, rents, interest and profit.


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This measure the amount added to the value of good at eachstage of the production process.

This is often referred as the value added approach

It is necessary to deduct the value of inputs or intermediate goodsto avoid double counting

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Stage of production

Value of

sales

Value

added

Oil drilling $0.50 $0.50

Refining

$0.65

$0.15

Shipping

$0.80

$0.15

Retail sales

$1.00

$0.20

Total value added

$1.00

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Gross Domestic Product (GDP)

GDP is the total money value of the all final goods and servicesproduced within a country in a given time period.

Also called asAggregate Output

Gross National Product (GNP)

GNP is defined as the total market value of all final goods andservices produced by the residence of a country during a givenperiod of time.

GDP plus any income earned by residents from overseasinvestments, minus income earned within the domestic economyby overseas residents.

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Nominal GDP - A gross domestic product (GDP) figurethat has not been adjusted for inflation.

Real GDPA GDP that has been adjusted for inflation toreflect the changes in the price level.

Price index- measure of the price of a specified collectionof G&S, called a marketbasket,in a given year.

Real GDP= nominal GDP/price index


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Year (1)

Unit of

Output

(2)

Prize of

Pizza per

Unit

(3)

Price Index

(4)

Unadjusted

or Nominal

GDP

(1) X (2)

(5)

Adjusted,

Real GDP

1 5 $ 10 100 $ 50 $ 50

2 7 20 200 140 70

3 8 25 250 200 80

4 10 30

5 11 28

Base year= Year 1


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1. Government pays National Insurance and social securitybenefits to individuals, but the recipients produce nothing inreturn.

2. Students received student grants from govt, but again producenothing which can be sold.

3. Children receive pocket money for allowance from theirparents.

4. An individual selling second hand car receives money, nut nonew car is created.

These are excludedfrom final calculations of nationalincome


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1. How economy works?

2. Planning

3. To make comparisons

4. Judgments about economic welfare


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1. The hidden economy

2. Home produced services

3. The public sector4. Statistical inaccuracies

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25-The Circular Flow of Income

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