Building the Circular Flow of Income & Spending

Building the Circular Flow of Income and Spending

Households Government Firms

Purchases of goods and services

£Demand

Supply

£Demand

Wages, dividends, interest, profits and rent

Supply

£Demand

£Incomes

Supply

£Demand

£Incomes

Supply

£Demand

£Incomes

Supply

£Demand

£Incomes

Supply

£Demand

£Incomes

Social Transfers

Supply

£Demand

£Incomes

Social Transfers

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

The Domestic Circular Flow

HouseholdsGovernment

Supply

Production by firms generates factor incomes

£Demand

£Incomes

Social Transfers

Govt Purchases

Rest of the World

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Rest of the World

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Rest of the World

Imports

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Rest of the World

Imports

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Rest of the World

Imports Exports

Supply

£Demand

£Incomes

Social Transfers

Govt Purchases

Injections and Leakages from

the Circular Flow

Rest of the World

Imports ExportsTrade balance

Supply

£ Demand

£Incomes

Social Transfers

Govt Purchases

the Circular Flow

Rest of the World

Supply

£ Demand

£Incomes

Social Transfers

Govt Purchases

the Circular Flow

Rest of the World

Capital Investment

Consumer Spending (C) Saving (S) Investment (I)

Define your terms accurately!

Household spending on goods and services

Deferred spending, disposable income that is not spent

Spending on capital goods including plant & machinery and infrastructure

Aggregate Demand (AD)

• Total demand for domestically-produced goods and services = GDP

• AD = the sum ofConsumer spending (C)+ Investment spending (I)+ Government spending (G)+ Exports of goods and services (X)- Imports of goods and services (M)

2:18:10 PM

Exports (X) Government Consumption Investment (I)

Injections into the Circular Flow

Goods and services sold to consumers (buyers) in overseas markets

State (public) sector demand for goods and services e.g. health and education

Spending on capital goods including plant & machinery and infrastructure

Imports (M) Taxation (T) Savings (S)

Leakages from the Circular Flow

Goods and services bought by domestic consumers and businesses from overseas

Compulsory payments to the government – direct and indirect taxes

Injections and leakages

Imports (M)

Taxation (T)

Savings (S)

Exports (X)

Government Consumption

Investment (I)

Imports (M)

Taxation (T)

Savings (S)

Exports (X)

Investment (I)

Balance of Trade

Imports (M)

Taxation (T)

Savings (S)

Exports (X)

Investment (I)

Balance of Trade

Government Budget Balance

Imports (M)

Taxation (T)

Savings (S)

Exports (X)

Investment (I)

Balance of Trade

Balance between

savings and investment

Imports (M)

Taxation (T)

Savings (S)

Exports (X)

Investment (I)

Balance of Trade

Balance between

savings and investment

Exports (X)

Investment (I)

Imports (M)

Taxation (T)

Savings (S)

When Injections > Leakages

Then the level of

Will tend to

Exports (X)

Investment (I)

Imports (M)

Taxation (T)

Savings (S)

When Injections > Leakages

Then the level of

Will tend to

Exports (X)

Investment (I)

Imports (M)

Taxation (T)

Savings (S)

When Leakages > Injections

Then the level of

Will tend to

Exports (X)

Investment (I)

Imports (M)

Taxation (T)

Savings (S)

When Leakages > Injections

Then the level of

Will tend to

Circular Flow Questions Economic event Which injection or

leakage is/are likely to be most affected?

X, I, G, S, M T

On balance - what is the likely effect on the level

of GDP– expansion or contraction (circle your

answer)

1. A survey finds a fall in confidence for UK manufacturing firms

X G I S M T () Expansion / Contraction ()

2. A survey finds that construction companies expect average house prices to rise by 5% in 2013

3. The pound rises in value by 10% against the US dollar ($)

4. The government decides to cut wages of civil servants

X, I, G, S, M T

answer)

5 China reduces in the size of an import tariff on British-made steel

6 A new forecast from the IMF suggests that unemployment in the UK will fall by 250,000 over the next two years

7 The government increases the rate of VAT from 20% to 22%

8 China reduces in the size of an import tariff on British-made steel

X, I, G, S, M T

answer)

9 The government decides to increase the UK road-building programme by £500m for 2013 and 2014

10 The prices of many consumer goods and services start to fall, and people start to expect further price reductions in the future

11 The Bank of England’s Monetary Policy Committee decides to raise official interest rates from 0.5% to 2% over a period of months

12 The government decides to increase the UK road-building programme by £500m for 2013 and 2014

X, I, G, S, M T

answer)

13 The government increases revenues from taxes on high-income earners by £2bn and uses the money to increase spending on welfare payments to low-income families at £2bn

14 Improvements in labour productivity causes lower costs and increased profits for car producers located in the UK

15 The Chancellor announces a reduction in the rate of national insurance contributions paid by small businesses

16 The government increases revenues from taxes on high-income earners by £2bn and uses the money to increase spending on welfare payments to low-income families at £2bn

UK Economic CycleQuarterly value of real GDP, £ billion measured at constant prices

Tracking the UK Economic Cycle - UK Real National Output

Source: UK Statistics Commission

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

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