THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

INTRODUCTORY MACROECONOMICS
By: Cristobal M. Pagoso Rosemary P. Dinio George A. Villasis

Prepared by: GREGAR DONAVEN E. VALDEHUEZA, MBA Lourdes College Instructor

Basic Economic Activities

Production
The use of economic resources in the creation of goods and services for the satisfaction of human wants.

Consumption
The using up of goods and services by consumer purchasing or in the production of other goods.

Employment
The use of economic resources in production; engagement in activity

Income Generation
The production of maximum amount an individual can spend during a period without being any worse off.

Two Economic Units

Household
The basic consuming unit.

Firm
The basic producing unit.

Stock and Flow Variables

Flow

A quantity measured over a particular period of time. A quantity measured as of a given point in time.

Stock

The concepts of stock and flow measurements are essential in understanding the economic variables of wealth and income.

Wealth

Anything of valued owned. It is a stock since it is what is owned at a particular time. The rate at which we earn money. It is a flow since income that is saved, increases the stock of wealth.

Income

Economic Model of Production

The Circular Flow of the Production Process
ECONOMIC RESOURCES

HOUSEHOLDS

PRODUCING UNITS

GOODS AND SERVICES

Circular Flow of Goods Among Production Units

RAW MATERIALS

RAW MATERIAL FIRM

INTERMEDIATE GOOD FIRM

CONSUMERS INTERMEDIATE GOODS

FINAL GOODS

FINAL GOOD FIRM

Interrelation Between Production Units & Households

RESOURCES RAW MATERIAL FIRM

HOUSEHOLDS

RESOURCES

INTERMEDIATE GOOD FIRM

RESOURCES

FINAL GOOD FIRM

Economic Model of Income and Consumption

The Circular Flow of Goods and Income Among Producers & Households
RESOURCES MONEY PAYMENT FOR RERESOURCES RESOURCES MONEY PAYMENT FOR RESOURCES HOUSEHOLDS RESOURCES MONEY PAYMENT FOR RESOURCES MONEY PAYMENT FOR PURCHASE OF FINAL GOODS FINAL GOODS FINAL GOOD FIRM RAW MATERIAL FIRM

INTERMEDIATE GOOD FIRM

The Circular Flow of Income

INCOME FLOW OF WAGES, INTERESTS, RENTS

HOUSEHOLDS

PRODUCING UNITS

PURCHASES OF GOODS AND SERVICES

Circular Flow of Income Among Production Units

MONEY PAYMENTS FOR RAW MATERIALS

RAW MATERIALS FIRM MONEY PAYMENTS FOR INTERMEDIATE GOODS FINAL GOOD FIRM

INTERMEDIATE GOOD FIRM

MONEY PAYMENTS FOR FINAL GOODS

HOUSEHOLDS

The Circular Flow of Output and Income

Circular Flow of Physical Goods and Money Income
Goods and Services Factors of Production (land, labor, capital, entrepreneur)

Household Sector

Business Sector

Payments of Factors (rent, wages, interest, profit) Payment of Purchase of goods and services.

The Circular Flow of Goods & Income of Households & Firms with the Government & Foreign Countries
GOVERNMENT Wages, Transfer Payments Taxes Economic Resources Purchase of Goods & Services HOUSEHOLDS Income Payments of Wages, Rent, Dividends, & Interests Goods & Services Money Payments for Imports FOREIGN COUNTRIES Money Payments for Exports PRODUCING UNITS Purchase of Goods & Services Taxes

Implications of the Circular Flow of Economic Activity

1.

The goods, resources, and money payments will flow as long as households continue to consume, and as long as firms continue to produce. That since goods and resources flow in exchange for payments, the rate of payments flow will in the end be the same. Money is the inducing factor, and the pillar of the price system. Without it, there is no price system.

2.

Inflows and Outflows

Outflows (factors that decrease the

level of economic activity)

Savings Taxes Imports

Inflows (factors that increase the level

of economic activity)
Investment Government Spending Exports

The Circular Flow of Economic Activity Reflecting The Outflows & The Inflows
Economic Resources Purchase of Goods & Services Income Payments of Wages, Rent, Dividends, & Interests Goods & Services IMPORTS TAXES SAVINGS Foreign Countries Government Banks EXPORTS EXPENDITURES INVESTMENTS

HOUSEHOLDS

PRODUCING UNITS

Outflows are difficult to control because they are dependent on income. When income increases, we expect savings, taxes, and imports to increase. Inflows are easier to manipulate. The proper use of policy enables the government to encourage exports and investments and to increase its expenditures when it desires to expand the flow of economic activity.

Three Sets of Policy

Monetary policy
Affects the savings and investment.

Fiscal policy
Controls taxes and government expenditures.

Trade policy
Affects a countrys exports and imports.

- THE END Any questions?

GOOD DAY!!!