Presentation on theme: "The Circular Flow of Income and Expenditure"— Presentation transcript:
1The Circular Flow of Income and Expenditure The circular flow diagram shows the transactions among households, firms, governments, and the rest of the world.
2The Circular Flow of Income and Expenditure Firms hire factors of production from households. The blue flow, Y, shows total income paid by firms to households.
3The Circular Flow of Income and Expenditure Households buy consumer goods and services. The red flow, C, shows consumption expenditures.
4The Circular Flow of Income and Expenditure Households save, S, and pay taxes, T. Firms borrow some of what households save to finance their investment.
5The Circular Flow of Income and Expenditure Firms buy capital goods from other firms. The red flow I represents this investment expenditure by firms.
6The Circular Flow of Income and Expenditure The Government buys goods and services, G, and borrows or repays debt if spending exceeds or is less than taxes
7The Circular Flow of Income and Expenditure The rest of the world buys goods and services from us, X and sells us goods and services, M—net exports are X - M
8The Circular Flow of Income and Expenditure And the rest of the world borrows from us or lends to us depending on whether net exports are positive or negative.
9The Circular Flow of Income and Expenditure The blue and red flows are the circular flow of income and expenditure. The green flows are borrowing, lending, and taxes.
10The Circular Flow of Income and Expenditure The sum of the red flows equals the blue flow. That is: Y = C + I + G + X - M
11Expenditures Expenditures are purchases of goods and services. Consumption expenditure (C)Investment expenditure (I)Government spending (on goods and services) (G)Net Exports (X-M)Exports (X)Imports (M)
12Expenditures equal Income Expenditures= C + I + G + X – MAll expenditures become someone’s income soY (income) = C + I + G + X – M
13Government Government spending: Goods and services (G) Roads, health care, education, helicopters, police officers salaries, judges salaries.Government revenue:Taxes(Income from Crown corporations)(Tariffs)Less Transfers to persons (part of net taxes)GST rebates, unemployment insurance, pensions, subsidiesInterest on the debt (substantial)NOTE: The gov’t is not buying services, so transfers are not an expenditure.
14Budgetary Deficits and Surpluses SpendingGoods and services (G) + Transfers to persons (Tr)RevenueTaxes (Tx)Net TaxesTx – Tr = NTSurplusG + Tr < TxG < Tx – TrG < NTDeficitG + Tr > TxG > Tx – TrG > NT
15Savings and Investment Investment is financed by savingsSavings have three sources:Savings by householdsThe part of income households do not spend on consumption or net taxes.(S = Y - C - NT)Savings by governmentsNT – G = savingsSavings of foreignersM – X = foreign borrowing
16STOCKS AND FLOWS FLOWS STOCKS Income : the goods and services produced each yearDeficits: The excess of spending over income each yearInvestment: Goods produced to be used in production each yearSurpluses: The excess of revenue over expenditures each year.STOCKSWealth: All the goods a person owns. Wealth is the sum of past net saving.Debt: the sum of all past deficits less all past surplusesCapital: All the investment goods owned. Capital is the sum of past net investment