LECTURE 4 - CIRCULAR FLOW

ECON

OMIC

LECTURE 4

CIRCULAR FLOW

STEVEN.REYNOLDS@CITYOFGLASGOWCOLLEGE.AC.UK

CIRCULAR FLOW

what is it?

the circular flow of the economy

The circular-flow diagram (or circular-flow model) is a graphical representation of the flows of goods and money between two distinct parts of the economy:

• The Households
• The firms

THE ELEMENTS

KEY FACTORS

FIRMS

HOUSEHOLDS & FIRMS

HOUSEHOLDS

The firms produces goods and services

Firms and households are in a two-sided relationship with each other:

• The flow of expenditure
• The flow of production (output)

The 'households‘ own the factors of production: Land ; labor ; Capital ; entrepreneurship.

THE FLOW OF PRODUCTION & INCOME

FLOW OF PRODUCTION

The firms require the factors of production to produce the goods and services The households provide these factors. The services of these factors (labour, land, capital, entrepreneurship) flows from the households to the firms The firms produce goods and services, thanks to the factors of production

FLOW OF INCOME

In exchange for the provision of the factors of production (provided by the households), the firms will provide various types of income (rents, wages, interests, profits). The provision of these incomes flows from the firms to the households The households will use these income to spend on goods and services

EQUALITY & INTERDEPENDANCE

The circular flow diagram illustrates the interdependence of the “flows,” or activities, that occur in the economy, such as:

• the production of goods and services (or the “output” of the economy) and

• the income generated from that production.

The circular flow also illustrates the equality between the income earned from production and the value of goods and services produced

ADDITIONAL INFLUENCES

KEY FACTORS

FINANCIAL INSTITUTIONS

FOREIGN SECTOR

GOVERNMENT

The firms produces goods and services

INVESTMENT / IMPORTS/EXPORTS

Due to their ability to set policies, laws, taxes and subsidies.

INJECTIONS VS WITHDRAWALS

Injections are additions and contributions to the economy through government spending, money from exports, and investments made by firms. Injections increase the flow of income.

Injections include:

Investment (I)

Government Spending (G)

Exports (X)

INJECTIONS VS WITHDRAWALS

Only part of the income received by households will be spent on goods and services. Some part will be withdrawn. There are three forms of withdrawals (sometimes they are called leakages). Withdrawals decrease the flow of income

Withdrawals include:

Savings (S)

Taxation (T)

Imports (I)

INJECTIONS VS WITHDRAWALS

THE RELATIONSHIP

There are links between saving and investment, taxation and government expenditure and imports and exports. For instance, if more money is saved, there will be more available for banks to lend out. It tax receipts are lower, the government may have to decrease its spending

Injections and withdrawals are unlikely to be at the same levels.

Although, when injections equal withdrawals, a state of equilibrium will exist.

CIRCULAR FLOW

PLEASE REVIEW

OVERVIEW

LESSON RECAP

• To describe the circular flow of income

• To explain how the different part of the circular flow of Income interact with each others

• To identify the flow of expenditure and the flow of production (output)

• To identify the injections and the withdrawals

THANKS

STEVEN.REYNOLDS@CITYOFGLASGOWCOLLEGE.AC.UK

MHAIRI.MCMAHON@CITYOFGLASGOWCOLLEGE.AC.UK