Chapter 22

2.1 AThe circular flow of income model Money is the measure

1For student handout: print slides 6-11On the other handMacroeconomics is the study of how the economy operates as a whole more than simply the sum of all markets and impacts on all micro markets.Microeconomics is the study of individual markets where households and firms make decisions and the big questions of an economy are answered.

2Macroeconomicsanswers questions like the following:How does a country get rich? Does rich mean better?Why do prices keep rising, sometimes rapidly? Why do we have unemployment?Why do we have to import so much?Why is it too easy to borrow money at times and very difficult at other times?

3The Five Macroeconomic GoalsGenerally, governments aim at achieving:sustainable real growth of incomegeneral price stability (low inflation)full employment (low unemployment)favourable balance of paymentsequitable distribution of income

Consumer SpendingFirmsGoods and ServicesHouseholdsReal FlowMoney FlowRecall: the basic circular flow modelResources (4 FoP)Household Income =payments from firms (rent, wages, interest and profit)

Lessons from the 2 sector circular flow modelEach real flow has a corresponding money flow that makes a market.Money only circulates to allow for real flows to function smoothly.An economy can be measured by either the income flow or the spending flow:ButExpenditure comes from more than households. And all household income is not spent.

6BANKS, etcGOV.Investment (I)Governmentexpenditure (G)Exportreceipts (X)Netsaving (S)Directtaxes (T)Importpayments (M)OverseasWITHDRAWALSINJECTIONSConsumption C = Y S TIncome(Y)expenditure

78Three measures of national incomeExpenditurethe sum of expenditures in the economyIncomethe sum of incomes all factor incomesOutputthe sum of output (value added) produced in the economy

All three approaches are should give you the same final figure for national income

8Calculating national income by The Expenditure MethodTotal spending by all sectors:C + I + G + X-M = GDP = YGDP is the market value of all reported final goods and services produced within a country in a given period of time.

9The Components of GDPConsumption (C):The spending by the Households Sector on goods and services (less net i.t. (indirect taxes - subsidies) to get to the market value of consumer spending).Investment (I):The spending on capital equipment, inventories, and structures, including new housing through the Financial Sector .(this can also be sourced from profits from the firm)

10The Components of GDPGovernment Purchases (G):The spending on goods and services by the Public Sector.(Does not include transfer payments because they are not made in exchange for currently produced goods or services.)Net Exports (NX):Exports minus imports, plus many more money flows that will be studied in section III from/to the Foreign/Trade/Overseas Sector.

11Withdrawals (W) and Injections (J)in an unchanging system, W = J butGT, as government budgets may adjust them separately, and may borrow/save overseasSI, as households (S) operate separately from firms (I), and banks multiply household savingsXM, as foreign consumers (X) operate separately from domestic consumers (M), resulting in trade imbalances

FirmsConsumer Spending HouseholdsIncomeFinancial SectorFinancial SectorSavingInvestmentFinancial SectorSavingInvestmentGovernmentTransfersTaxationGovernment spendingComplete circular flow diagramGovernmentTransfersTaxationGovernment spendingOverseas sectorExport receiptsImport paymentsGovernmental Sector