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Modeling the Economy
Actors:
1. Consumers2. Financial Institutions3. Businesses4. The Government5. The Foreign Sector
Circular Flow Model
Consumers can engage in 3 actions:
1. Consumption (C)2. Savings (S)3. Paying Taxes (T)
FinancialInstitutions
S C Consumers
TGovernment
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. Savings2. Taxes
Financial Institutions are:
1. Banks2. The Stock Market3. 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 stocksBusinessesInstitutions bonds I
CB S C Consumers
TGovernment
The Government
1. Collects Taxes (T) – leakage2. Spends Money (G) - injection3. 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 stocksBusinessesInstitutions bonds I
CB S C ConsumersTP TGovernment GB
G
The Foreign Sector
1. Buys things made in the USexports (X) are the 4th injection
2. Sells things to the USimports (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
FSFinancial stocksBusinesses FBInstitutions bonds I Foreign
SectorCB S C X IM ConsumersTP TGovernment 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 wages2. capital is paid interest3. land is paid rent4. entrepreneurs are paid profit
FSFinancial stocksBusinesses FBInstitutions bonds I Foreign
SectorCB S C X IM ConsumersTP TGovernment Income GB wages, interest, rent, profit G