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The Circular Flow of Income and Expenditure

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Okun's law states a regular negative relationship between them. ... Output ratio falls in recession period that cause unemployment rate to rise. ... – PowerPoint PPT presentation

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Title: The Circular Flow of Income and Expenditure


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The 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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Introduction 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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Introduction 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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The 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)

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The 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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What 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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Households 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

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Households 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

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Nominal 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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Unemployment 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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