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The Circular Flow Model. Shows the economic transactions that occur between households, firms and other sectors in the economy. Money flows- We will only.

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Presentation on theme: "The Circular Flow Model. Shows the economic transactions that occur between households, firms and other sectors in the economy. Money flows- We will only."— Presentation transcript:

1 The Circular Flow Model

2 Shows the economic transactions that occur between households, firms and other sectors in the economy. Money flows- We will only focus money flows as it is simpler than trying to account for the physical flows.

3 The Circular Flow of Income and Spending The simplest form of circular flow Households Producers Incomes $ rent wages interest profit $ Consumption Goods and Services Factors of production (Land, Labour, Capital

4 Introduction of the Financial Sector a b d c Households Producers Financial Institutions C (Payments for goods and services) Y (Income) S (savings) I (Investment)

5 The financial Sector Households do not spend all the income they earn they also save some. Savings = Income – Consumption Households usually save their income with banks. Banks then use this money to lend to firms. Firms then use these loans for investment (purchase capital)

6 Interest When firms borrow from banks they pay interest in return for these loans. Banks however, also pay interest to households for saving money with them. BUT! Banks will charge a higher interest to borrowers than what they pay to savers. This is how they make an income. E.g Joe saves 100 with BNZ and earns 5% interest in return for saving. BNZ then loans some of this money out but charges 10% for loans.

7 Open Economy Not all goods available in NZ are produced in NZ. – Imports = Goods made overseas but sold in NZ Not all goods produced in NZ are sold here. – Exports = Goods made in NZ but sold overseas Exports and Imports are real flows. They are actual goods and services being traded internationally. Producers Overseas Sector Imports Exports

8 Money Flows – Export receipts= payments from overseas firms to NZ firms for the goods and services exported overseas. – Import Payments = NZ producers payments to overseas firms for the goods and services they have imported. – Remember export receipts are coming into NZ – Import payments are leaving NZ Producers Overseas Sector Imports Exports Export Receipts Import Payments

9 An Open Economy a b c d f g Households Producers Financial Institutions Overseas Sector C (consumption) Y (Income) S (Savings) I (Investment) X (Export receipts) M (Import payments)

10 Role of the Government The government collects taxes – PAYE (pay as you earn) Income tax – GST (goods and services tax) 15% tax on any good or service you consume. – Company Tax – Taxes paid by producers to the government Transfers – Subsidies that go to producers – Social Welfare- (Sickness benefit, superannuation, unemployment benefit) this flow goes straight to households. Government Spending – Providing goods and services. (Schools, hospitals and the police force) – Payment for goods and services

11 Role of the Government a b c d f g Households Producers Financial Institutions Overseas Sector C (consumption) Y (Income) S (Savings) I (Investment) X (Export receipts) M (Import payments) Government a b c tr (transfers) T (taxes) G (Government Spending)

12 The Circular Flow Model a b c d e f h g i C (consumption) Households Producer Financial Institutions Overseas Sector Y (Income) S (Savings) I (Investment) X (Export receipts) M (Import payments) T (taxes) tr (transfers) G (Government Spending) Government

13 The Circular Flow model Y= Incomes including rent wages interest and profit C= Consumption spending- the payment for goods and services S= Savings – income not spent on consumption this is a withdrawal from the economy I= Investment spending-purchase of capital goods. This is an injection into the economy X= Export receipts- Money received for exports sold M= Import payments- Payments made for imports purchased G= Government Spending- on collective goods T= Taxes the government collects from households and firms. These are used to fund G and Tr. Tr= Transfer money from one group to another, because of this transfer payments are not true expenditure.

14 Withdrawals and Injections Withdrawal = A money flow that leaves the circular flow – I= Investment spending-purchase of capital goods. This is an injection into the economy – X= Export receipts- Money received for exports sold – G= Government Spending- on collective goods Injection= Flows of money into the circular flow model – S= Savings – income not spent on consumption this is a withdrawal from the economy – M= Import payments- Payments made for imports purchased – T= Taxes the government collects from households and firms. These are used to fund G and Tr.

15 Money and Real Flows - Notes Money Flow – are the payments made for goods purchased or the services being provided. – E.g the payment of wages in return for the use of labour Real Flow – are the movements of actual goods and services between different sectors of the economy – E.g. the use of labour by a producer


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