Title: The Circular Flow of Income and Expenditure
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2The Circular Flow of Income and Expenditure
- Firms sell product to households and earn
consumption expenditures from households. - Households provide labor services to firms and
earn incomes from firms - Income (Y) labor services consumption
expenditures (C) product
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4Introduction of Saving and Investment to the
Circular Flow Diagram
- Y C Saving (S)
- S can be in terms of bonds and stocks issued by
firm or deposits in financial institutions. - S (leakages) flow to capital market and turn into
investment (injections).
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6Introduction of Government, Foreign Sectors to
the Circular Flow Diagram
- Government sector activities collect tax revenue
(R), make transfer payments (F), issue bonds in
capital market and make purchase of product (G). - Foreign sector activities export (X) and import
(M) of product
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8The Circular Flow in Equations
- Y E
- E C I G X M C I G NX
- Y F C S R
- Y C S (R F) C S T
- C S T C I G NX
- So, S T (Leakages) I G NX (Injections)
9The Circular Flow in Equations (Cont)
- By rearranging T G (I NX) S
- Three ways that (T G) surplus can use
- (i) allows private saving to decline without any
need for a decline in total investment - (ii) stimulates domestic investment
- (iii) boosts foreign investment
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11What Transactions should be Includes in GDP?
- Final product (?) all currently produces goods
and services that are sold through the market but
not resold during the current time period. - Government interest and transfer payment (?) the
recipients havent provide product in return. - Private purchases of used assets (?) no
currently produced product. - Non-market activities (?) product no sold on the
market - Intermediate product (?) to avoid double-counting
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13Households Get What Remains after after all the
Leakages
C I G NP GDP at market price
- Indirect business taxes
- Subsidies
- GDP at factor cost
- Depreciation
- NDP at factor cost
- Undistributed profits
- Social security and corporate taxes
14Households Get What Remains after after all the
Leakages (Cont)
- Direct business taxes
- Transfer payments and interests
- Personal income
- Personal income taxes
- Personal disposable income
- Consumption expenditure
- Saving
- Interest payments
- 0
15Nominal GDP, Real GDP and The GDP Deflator
- Nominal GDP is the value of GDP in the current
market prices. - Since ?Nominal GDP can either ? in real
production or ? in prices, it suffers from
defects. - Real GDP is the value of GDP in the constant
(base year) market prices - GDP Deflator Nominal GDP/Real GDP
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17Unemployment Rate VS Output Ratio
- Okuns law states a regular negative relationship
between them. - Output ratio rises in boom period that causes
unemployment rate to fall - Output ratio falls in recession period that cause
unemployment rate to rise.
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