12680 nat inc flow.ppt

Copyright 2005 McGraw-Hill Australia Pty Ltd

PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 15-1

PART 7THE CIRCULAR FLOW AND ECONOMIC FLUCTUATIONSChapter 15The Circular Flow



Lecture Plan

• The exchange flow between households and the business sector

– The two-sector economy

• The exchange flows with financial markets– The financial sector and the three-sector economy

• The exchange flows between households, businesses and government

– The government sector and the four-sector economy

• Exchange flows with other countries– The overseas sector and the five-sector (open) economy



The Circular Flow of Goods and Money• In a capitalistic/mixed economy money is used to

– Buy and sell goods and resources in markets– Pay and collect taxes– Borrow and lend in financial markets

• The ABS structures the Australian national accounts around the five sectors of the economy i.e.

– Businesses, households– Financial, government, overseas sectors



The Two-sector Model of the Economy (Households and Firms) • The households (consumers):

– Require goods and services to satisfy their personal wants

– Own all resources (i.e. labour, capital, land, enterprise) – Sell resources to businesses– Gain income (e.g. wage, interest, rent, profit) from such

sales• The firms/business sector (producers):

– Uses resources provided by households to produce goods and services

– Sells those goods and services for income



The Two-sector Model of the Economy

• Assumptions:– Businesses are the only producers– All goods and services are sold to consumers– Consumers spend ALL their income on goods and

services– There are no resource inventories

• Therefore:• Total demand (expenditure) = total supply (output) • The economy will always be in equilibrium

(cont.)



The Two-sector Model of the Economy (cont.)

• Two groups of decision makers– Households (sell their resources)– Firms (sell goods and services)

• Interaction between the two sectors through markets:– Resource (factor) markets– Product markets

(cont.)



Productive resources

Income

Expenditure

Goods and Services

Household sector

Product market

Firms sector

Factor market




In the Basic Circular Flow

O = Y = E

Where:

O = output (production)

Y = income

E = expenditure (demand)



The Financial Sector• Saving (S) = Part of the Income that is not spent

(leakage)• Total income = consumption spending + saving, i.e.

Y = C + S

• Investment (I) = that part of production that is not used for current consumption, e.g. capital goods

Total income (Y) = C + I• Investment is an injection. If:

S > I, the economy contractsS < I, the economy expandsS = I, the economy is in equilibrium

• The financial sector acts as an intermediary between lenders and borrowers



The Government Sector

• Government taxation (T) reduces households’ disposable income and business funds

Taxation (T) is a leakage (outflow) • Government spending (G) includes expenditure on

collective goods and services and goods and services provided by the business sector, plus transfer payments (social security payments)



The Modified Five-sector Model of the Economy

It is a five-sector model of the economy:• The household sector

• The firms sector• The government sector• The financial sector• The external (overseas) sector



Household sector

Financialsector

Governmentsector

Externalsector

Firmssector

Imports

Savings

Government expenditure

Exports

Taxation

Investment

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Expenditure

Income




The Open Economy

• Total leakages (outflows) are S, T and M• Total injections are I, G and X• The impact of total leakages/injections on the

economic activity is as follows:

S + T + M = I + G + X equilibrium

S + T + M > I + G + X contraction

S + T + M < I + G + X expansion

Education

12680 nat inc flow.ppt