1 1 1. The Circular Flow of Income and Expenditure 2. The Production Possibility Frontier Macro Economic Model 2 First Model: The Circular Flow of Income and Expenditure In an economy millions of people are buying, selling, working, hiring. Since economy as an integrated system of production, exchange and consumption, it has two types of decision makers 1. Producers(Seller): who produces goods and services and sale in the market , receives income 2. Consumer ( Buyer): who spends money in exchange for goods and services bought , made expenditure Buy and sell goods and services – Production flow ( Income) – Money Flow ( Expenditure) So total income = total expenditure at a point of time
Transcript
1
1
1. The Circular Flow of Income and Expenditure
2. The Production Possibility Frontier
Macro Economic Model
2
First Model: The Circular Flow of Income andExpenditure
In an economy millions of people are buying, selling, working, hiring.Since economy as an integrated system of production, exchange andconsumption, it has two types of decision makers
1. Producers(Seller): who produces goods and services and sale in the market , receives income
2. Consumer ( Buyer): who spends money in exchange for goods and services bought , made expenditure
Buy and sell goods and services– Production flow ( Income)– Money Flow ( Expenditure)So total income = total expenditure at a point of time
So we have circular flow of Income and Expenditure for1. One Sector 2. Two Sector3. Three Sector4. Four Sector
4
The Circular Flow of Income and Expenditure: One Sector Model
• Households is the only one sectorEx, Robinson Crusoe , who lived an island
Whatever it produces, it consumes
So his aggregate supply AS=Y=f (N)
His aggregate demand AD=C
Equilibrium: AD= AS
=>Y=C
3
5
The Circular Flow of Income and Expenditure: Two Sector Model
Two Sector:1. Households:
1. Owner of all factors of productions: L,N, K, O
2. Total income= R+w+i+p
3. Consumes goods and services
4. Made Expenditure on goods and services
2. Firms/Industry:1. They own no resources of their own
2. Hire and use factors of production: L, N, K, O
3. Make Factor Payments
4. Produces and sell goods and services to households
5. No saving
6
The Circular Flow of Income and Expenditure: Two Sector Model
Assumptions:
– Only Two sectors• Producers(Firms): provide all the Goods and Services
– No inventory.
– Make factor payment R, w, i and p.
• Consumers(Household): spend all their Income on goods an services.
– No Savings.
– Owners of productive resource - land, labour, capital and enterprise
– All production is sold to the consumers
– No government and no overseas sectors
– No inflow or outflow of income or goods and services outside or inside.
4
7
The Circular Flow of Income and Expenditure: Two Sector Model
8
The Circular Flow of Income and Expenditure: Two Sector Model
Important Identities:Household Income (Y) Y=FPFirm’s Factor Payment (FP) FP= R+w+i+pIdentity: Y≡ R+w+i+p
Household Expenditure:(E) E=YFirm’s Supply of goods and services (Z) Y=VIdentity: Y≡V
Means Households income (Y) ≡ Factor Payments (FP) ≡ Money Value of
Goods and Services (V)So
Y ≡ FP ≡ V
5
9
The Circular Flow of Income and Expenditure: Two Sector Model
(With Savings and Investment)
Withdrawals and Injections:
Withdrawals: An amount that is set aside by thehouseholds and firms and is not spent ondomestically produced goods and services over a periodof timeEx. Savings is an withdrawals
Injections: An Injections is the amount that is spent byhouseholds and firms in addition to thatincome generated within a regulatedeconomy.Ex. or Own hoarding or borrowing and spending i.e.
Investment is an injection
10
The Circular Flow of Income and Expenditure: Two Sector Model
(With Savings and Investment)
Flow of Money
Flow of Goods and Services
All saving are made by households and entered to the firm through financial markets, So, S=I
6
11
The Circular Flow of Income and Expenditure: Three Sector Model
Three Sector:
1. Households
2. Firms/Industry
3. Government
1. Revenue: Direct taxes
2. Expenditure: Govt. spending on goods and services
3. Transfer payment: pension, unemployment benefit
If G=T balanced budgetIf G>T deficit budgetIf G<T surplus budget
12
The Circular Flow of Income and Expenditure: Three Sector Model
7
13
The Circular Flow of Income and Expenditure: Three Sector Model
Withdrawals Taxes are withdrawals as they reduces the
pvt disposable income of the households
Injections Govt Exp are injections as they add to
their income Transfer payment are also injections as
they add income
14
The Circular Flow of Income and Expenditure: Four Sector Model
1. Households: C
2. Firms/IndustryI
3. Government
Revenue: Direct taxes (T) Expenditure: Govt. spending on goods and services (G) Transfer payment (tr)
4. External SectorImport (M)Export(X)
8
15
The Circular Flow of Income and Expenditure: Four Sector Model
Assumptions:
• The external sector consists of only exports(X) and imports)
• The export of goods and services and non-labour services are only made by firms
• Households only exports labor
• If X>M net gain from trade
• If X<M net loss from trade
• If X=M leave the circular flow unaffected
16
The Circular Flow of Income and Expenditure: Four Sector Model
9
17
The Circular Flow of Income and Expenditure: Four Sector Model
Withdrawals Imports are withdrawals as they
reduces the income of the households
Injections Exports are injections as they add to
their income
FirmsHouseholds
Market for Factors of Production(Factor Flow)
Market for Goods and Services(Goods Flow)
SpendingRevenue
Rent, wages, interest and profit Income
Goods & Services sold Goods & Services bought
Land, Labor, Capital and Entrepreneur
Inputs for production
Capital Market
Investment Savings
Government Direct TaxesDirect and indirect Taxes
Govt Purchse and Subsidies Wages, Salaries and transfer Payment
Foreign SectorReceipts from exports Foreign Remittance
Export of man powerPayments for imports
10
Second Model: The Production Possibilities Frontier
• The Production Possibilities Frontier (PPF): a graph that shows the combinations of two goods the economy can possibly produce given the available resources and the available technology
• Example:
– Two goods: computers and wheat
– One resource: labor (measured in hours)
– Economy has 50,000 labor hours per month available
for production.
PPF Example
• Producing one computer requires 100 hours labor.
• Producing one ton of wheat requires 10 hours labor.
5,0000
4,000100
2,500250
1,000400
50,0000
40,00010,000
25,00025,000
10,00040,000
0500050,000
E
D
C
B
A
WheatComputersWheatComputers
ProductionEmployment of
labor hours
11
Point on
graph
Production
Com-puters
Wheat
A 500 0
B 400 1,000
C 250 2,500
D 100 4,000
E 0 5,0000
1,000
2,000
3,000
4,000
5,000
6,000
0 100 200 300 400 500 600
Computers
Wheat (tons)
A
B
C
D
E
PPF Example
21
22
The Production Possibilities Frontier
Productionpossibilitiesfrontier
b
d
a
Quantity ofComputesrProduced
1,500
300
500
500 400
1,000
5,000
500
Quantity ofWheat
Produced
c
a. Efficiencyb. Trade-offsc. Opportunity costd. Economic growth
12
23
A Shift in the Production Possibilities Frontier
Quantity ofComputers Produced
1500
300
1700
3500
8,000
5,000
500
Quantity of
Wheat
Produced
A
G
24
Thank You All
13
Circular flow of Income and Expenditure: Two Sector Model
FirmsHouseholds
Market for Factors
of Production(Factor Flow)
Market for Goods
and Services(Goods Flow)
SpendingRevenue
Factor payment=Rent, wages, interest and
profit
Factor Income
Goods & Services sold
Goods & Services bought
Land, Labor, Capital and Entrepreneur
Inputs for production
Circular flow of Income and Expenditure: Two Sector Model
FirmsHouseholds
Market for Factors
of Production(Factor Flow)
Market for Goods
and Services(Goods Flow)
SpendingRevenue
Rent, wages, interest and profit
Income
Goods & Services sold
Goods & Services bought
Land, Labor, Capital and
Entrepreneur
Inputs for production
Capital MarketInvestment Savings
14
FirmsHouseholds
Market for Factors of Production(Factor Flow)
Market for Goods and Services(Goods Flow)
SpendingRevenue
Rent, wages, interest and profit Income
Goods & Services sold Goods & Services bought
Land, Labor, Capital and Entrepreneur
Inputs for production
Capital Market
Investment Savings
Government Direct TaxesDirect and indirect Taxes
Govt Purchse and Subsidies Wages, Salaries and transfer Payment
Foreign SectorReceipts from exports Foreign Remittance
