Circular flow of income and expenditure

1. Macroeconomics 2012 Prof Michael T.  NoelCollege of Business Administration Education

2. Topics:  Definition of Macroeconomic  Macroeconomic problem  Circular flow of income and expenditure

3. What is macroeconomics? Macroeconomics: analysis of the economy as a whole. Factors affecting macroeconomics output (GDP or GNP) a. consumption expenditure b. Investment expenditure c. Government expenditure d. Balance of payment

4. The Economic Problem:  How do we use scarce resources to best satisfy unlimited human wants?

5. Illustration of macroeconomicproblems Input: a. Consumption expenditure b. Investment Output: expenditure GDP/GNP c. Government expenditure d. Balance of payment

6. GROSS DOMESTICPRODUCT  The market value of all goods and services produced within a country in a given period of time.  It can be measured as all the EXPENDITURES to buy the goods and services produced.  It can also be measured as all the INCOME earned from producing the goods and services.  Since every peso spent is someone’s income, the two measures give the same result.

7. Flow of income and expenditureis present in every economicactivities A. Consumption B. Production C. Taxation D. Transfer of payment E. Imports F. Exports

8. Gross Domestic Product The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world.

9. Gross Domestic Product Firms hire factors of production from households. The blueflow, Y, shows total income paid by firms to households.

10. Gross Domestic Product◦Households buy consumer goods and services. The redflow, C, shows consumption expenditures.

11. Gross Domestic ProductHouseholds save, S, and pay taxes, T. Firms borrow some ofwhat households save to finance their investment.

12. Gross Domestic Product◦Firms buy capital goods from other firms. The red flow Irepresents this investment expenditure by firms.

13. Gross Domestic Product◦Governments buy goods and services, G, and borrow orrepay debt if spending exceeds or is less than taxes

14. Gross Domestic ProductThe rest of the world buys goods and services from us, X andsells us goods and services, M—net exports are X – M

15. Gross Domestic ProductAnd the rest of the world borrows from us or lends to usdepending on whether net exports are positive or negative.

16. Gross Domestic Product◦The blue and red flows are the circular flow of income andexpenditure. The green flows are borrowing, lending, and taxes.

17. Gross Domestic ProductThe sum of the red flows equals the blue flow.

18. Gross Domestic Product◦That is: Y = C + I + G + X – M

19. Expenditures Expenditures are purchases of goods and services. Expenditures are ◦ Consumption (C) ◦ Investment (I) ◦ Government spending (on goods and services) (G) ◦ Net Exports (X-M)  Exports (X)  Imports (M)

20. Expenditures equal Income  Expenditures= C+I+G+X–M  All expenditures become someone’s income so Y (income) = C + I + G + X – M

21. Government  Government spending: ◦ Goods and services (G)  Roads, health care, education, helicopters, police officers salaries, judges salaries.  Government revenue: ◦ Taxes ◦ (Income from Crown corporations) ◦ (Tariffs) ◦ Less Transfers to persons (part of net taxes)  GST rebates, unemployment insurance, pensions, subsidies  Interest on the debt (substantial)  NOTE: The gov’t is not buying services, so transfers are not an expenditure.

22. Budgetary Deficits andSurpluses  Spending  Surplus ◦ Goods and services  G + Tr < Tx (G) + Transfers to  G < Tx – Tr persons (Tr)  G < NT Revenue  Deficit ◦ Taxes (Tx)  G + Tr > Tx Net Taxes  G > Tx – Tr ◦ Tx – Tr = NT  G > NT

23. Savings and Investment  Investment is financed by savings  Savings have three sources: ◦ Savings by households  The part of income households do not spend on consumption or net taxes.  (S = Y – C – NT) ◦ Savings by governments  NT – G = savings ◦ Savings of foreigners  M – X = foreign borrowing

24. STOCKS AND FLOWS FLOWS  STOCKS ◦ Income : the goods and ◦ Wealth: All the goods a services produced each person owns. Wealth is year the sum of past net ◦ Deficits: The excess of saving. spending over income ◦ Debt: the sum of all past each year deficits less all past ◦ Investment: Goods surpluses produced to be used in ◦ Capital: All the production each year investment goods ◦ Surpluses: The excess owned. Capital is the of revenue over sum of past net expenditures each year. investment

25. Study well