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Circular Flow of Income
A model that indicates how money moves throughout an economy, between businesses and individuals.
Investors spend their income by consuming goods and services from business, paying taxes and investing in the stock market.
Businesses use the money spent by individuals while consuming and the money raised from selling stock to pay for capital to run their business, purchase material to manufacture products and to pay employees.
All expenditures from individuals become the income of the businesses, and the expenditures of the businesses become the income of the individuals.
Circular Flow…. The circular flow of income is a theory that describes the movement
of expenditure and income throughout the economy.
In an economy households provide factors of production, such as labor, to firms. Firms use these factors to produce goods and services which they sell to the households. (This is represented by the red, inner loop in the diagram below.)
The households then spend money on the goods and services produced by firms. This money is then used by firms to pay the households for their work, through wages. (This is represented by the green, outer loop in the diagram below.) This process repeats itself and forms the circular flow of income.
Diagrams
National Income The total net value of all goods and services
produced within a nation over a specified period of time, representing the sum of wages, profits, rents, interest, and pension payments to residents of the nation.
(Economics) economics the total of all incomes accruing over a specified period to residents of a country and consisting of wages, salaries, profits, rent, and interest.
Concepts you must be aware…
Gross Domestic Product GDP Gross National Product GNP Net National Product NNP Personal Disposable Income PDI Personal Income PI
GDP (Gross Domestic Product)
The value of country's overall output of goods and services (typically during one fiscal year) at market prices, excluding net income from abroad.
Income from abroad means the nationals of the country working in other countries. Their remittances include in GNP of their country & in GDP of the country where they are serving.
GDP = GNP – Income from abroad
GNP (Gross National Product)
Gross National Product GNP is the total market value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad)
Basically, GNP measures the value of goods and services that the country's citizens produced regardless of their location.
GNP is one measure of the economic condition of a country, under the assumption that a higher GNP leads to a higher quality of living, all other things being equal.
Unproductive transactions like pensions, old age benefits & bonuses are excluded from GDP
NNP Net National Product
The total net market value of final goods & services of a nation or country produces in a year.
It subtracts the depreciation on capital goods Mathematically
NNP = GNP - Depreciation
Personal Income
Total compensation received by an individual. Personal income includes compensation from a number of sources - salaries, wages and bonuses received from employment or self-employment; dividends and distributions received from investments; rental receipts from real estate investments; profit-sharing from a business and so on. In most jurisdictions, personal income above a certain exemption threshold is subject to taxation. Personal income is generally computed on a pre-tax basis.
Also referred to as "gross income."
How to compute Personal Income
Corporate profit Tax (-) Undistributed corporate profits (-) Social Security Contribution(-) Government Transfer Payments (+) Remittances from abroad (+) Business Transfer Payments (+)
Personal Disposable Income
This is the segment of the income that is actually available to consume.
in fact, individuals & households have to pay some taxes in form of income tax, property tax, withholding tax etc.
PDI = PI –Personal Direct Taxes
GDP Calculation by Expenditure Approach
GDP Calculation by Expenditure Approach
GDP Calculation by Expenditure Approach
GDP Calculation by Expenditure Approach
GDP Calculation by Expenditure Approach
GDP = C + I + G + (X- M) C = Private consumption expenditure I = Investment Expenditure G= Government Consumption
Expenditure X = Value of Exports M = Value of Imports
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP Calculation by Income Approach
GDP= Y+r+i+p+EY+Bt+D+NF income Y= Employees Compensation r= Rent, i= Interest & p= corporate profits EY= Entrepreneur's Income Bt= Business Taxes NF= Net foreign factor income
GDP by Product or Value Approach
GDP Defined GDP or gross domestic product is the market
value of all final goods and services produced in a country in a given time period.
This definition has four parts: Market value Final goods and services Produced within a country In a given time period
GDP by Product or Value Approach
Two Things To Avoid
Intermediate Goods
Transfer Payments
Two Things to Avoid when Compiling GDP
Multiple counting Only expenditures on final products – what
consumers, businesses, and government units buy for their own use belong in GDP
Intermediate goods are not counted Used goods are not counted
Two Things to Avoid when Compiling GDP
Transfer payments Transfer payments are not payments for currently
produced goods and services
When they are spent for final goods and services they will go into GDP as consumer spending
Financial transactions don’t go into GDP
Things to Avoid when Compiling GDP
Why only Final Goods…??
What is counted? What is not?
This is confusing…..!
The tires that come with the car is not counted as a final good However if you get a flat and buy the same tire it is counted as final good
Value Added Approach Eliminates Double Counting
Purpose of calculating National Income
Economic Trend Analysis Economic Growth, welfare Per capita income, state & city contribution Distribution of income Taxation policies & methods Forecasting future & planning for unemployment,
illiteracy, inflation & over population Preparation of Annual Budget
Problems in measuring National Income Non-Market activities Improved Product Quality Underground Economy Barter System Lack of proper recording Inefficient Government Department Tax Eradication Double counting Differentiation in economic functioning Foreign Payments
