Circular flow of income and expenditure

1. Macroeconomics
2012
Prof Michael T. Noel
College 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 macroeconomic
problems
Input:
a. Consumption
expenditure
b. Investment Output:
expenditure GDP/GNP
c. Government
expenditure
d. Balance of
payment

6. GROSS DOMESTIC
PRODUCT
 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 expenditure
is present in every economic
activities
A. Consumption
B. Production
C. Taxation
D. Transfer of payment
E. Importation
F. Exportation

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 blue
flow, Y, shows total income paid by firms to households.

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

11. Gross Domestic Product
Households save, S, and pay taxes, T. Firms borrow some of
what households save to finance their investment.

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

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

14. Gross Domestic Product
The rest of the world buys goods and services from us, X and
sells us goods and services, M—net exports are X - M

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

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

17. Gross Domestic Product
The 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 and
Surpluses
 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