2The Circular Flow Model 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.
3The Circular Flow of Income and Spending The simplest form of circular flow$ ConsumptionGoods and ServicesProducersHouseholdsThe inner ring shows the real flow of goods and servicesThe outer ring shows the money value of the flows.Factors of production(Land, Labour, CapitalIncomes $ rent wages interest profit
4Introduction of the Financial Sector I (Investment)dFinancial InstitutionsC (Payments for goods and services)aS (savings)cProducersHouseholdsName each of the money flowsSavings is a type of withdrawal. As savings is income not consumed. Saving does not have to necessarily be in the form of money for example it can be in the form of storing products. But any real saving is shown leaving the economic system.The role of the financial sector is to transfer money from those who wish to save and those who wish to invest. Investment is simply creating capital goods.What are capital goods?Who knows how financial institutions such as banks make revenue?Banks help transfer money. They create a more efficient flow in the economy that would occur without them but not as efficiently. Without banks less investment would occur and therefore economic growth would be held back.bY (Income)
5The financial SectorHouseholds do not spend all the income they earn they also save some.Savings = Income – ConsumptionHouseholds usually save their income with banks.Banks then use this money to lend to firms.Firms then use these loans for investment (purchase capital)
6InterestWhen 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.
7Open Economy Not all goods available in NZ are produced in NZ. Overseas SectorNot all goods available in NZ are produced in NZ.Imports = Goods made overseas but sold in NZNot all goods produced in NZ are sold here.Exports = Goods made in NZ but sold overseasExports and Imports are real flows. They are actual goods and services being traded internationally.ImportsExportsProducers
8Money FlowsOverseas SectorExport 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 NZImport payments are leaving NZExportsImport PaymentsExport ReceiptsImportsProducers
9An Open Economy Overseas Sector d Financial Institutions f a g c I (Investment)dFinancial InstitutionsX (Export receipts)fM (Import payments)C (consumption)agS (Savings)cWho knows what the difference is between an open and a closed economy?Exports are goods or services made in the home economy but sold to people overseas. Therefore export receipts are the payments for these exportsImports are goods or services made overseas but bought by people in the domestic economy. What examples or imports can you think of?Import payments are the payments for these imports. So they are a withdrawal from the economy.ProducersHouseholdsbY (Income)
10Role of the Government The government collects taxes Transfers PAYE (pay as you earn) Income taxGST (goods and services tax) 15% tax on any good or service you consume.Company Tax – Taxes paid by producers to the governmentTransfersSubsidies that go to producersSocial Welfare- (Sickness benefit, superannuation, unemployment benefit) this flow goes straight to households.Government SpendingProviding goods and services. (Schools, hospitals and the police force)Payment for goods and services
11Role of the Government Overseas Sector d Financial Institutions f a g I (Investment)dFinancial InstitutionsX (Export receipts)fM (Import payments)C (consumption)agS (Savings)ccG (Government Spending)Transfer payments are those payments by the government that represents and injection into the circular flow Such as welfare payments the DPB, subsidies etcBoth firms and households pay taxation to the government. This represents a withdrawal.Government spending is the money that the government spends in the economy. This is in the form of public goods such as health care, roading etc. The govenrment can be a producer or a provider. As a producer, sales from SOE would represent C not G.ProducersHouseholdsGovernmentT (taxes)tr (transfers)babY (Income)
13The Circular Flow model Y= Incomes including rent wages interest and profitC= Consumption spending- the payment for goods and servicesS= Savings – income not spent on consumption this is a withdrawal from the economyI= Investment spending-purchase of capital goods. This is an injection into the economyX= Export receipts- Money received for exports soldM= Import payments- Payments made for imports purchasedG= Government Spending- on collective goodsT= 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.
14Withdrawals and Injections Withdrawal = A money flow that leaves the circular flowI= Investment spending-purchase of capital goods. This is an injection into the economyX= Export receipts- Money received for exports soldG= Government Spending- on collective goodsInjection= Flows of money into the circular flow modelS= Savings – income not spent on consumption this is a withdrawal from the economyM= Import payments- Payments made for imports purchasedT= Taxes the government collects from households and firms. These are used to fund G and Tr.
15Money 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 labourReal Flow – are the movements of actual goods and services between different sectors of the economyE.g. the use of labour by a producer