3 Relationship Between Outcome and Income The Circular Flow Model shows two distinct monetary flows. Households offer factors of production to firms in return for household income. Households then use this income to make expenditures on goods and services. Example: Mr Teacher offers his labour to CIS in return for (not that much) money. Mr. Teacher uses this income to buy (not a lot of) goods and services.
4 So the income flow= expenditure flow=value of output Important Point!The income flow from firms to households (Mr. Teacher's salary) = the expenditures of Mr. Teacher for goods and services.Income from the factors of production must equal the expenditures by households on goods and services. In addition, the income flow and the expenditure flow will be equal to the value of total output produced by firms. So the income flow= expenditure flow=value of output
6 What effect does this have on the size of the economy? LeakagesLeakages occur when people take actions that decrease the flow of money through the circular flow diagram. What effect does this have on the size of the economy?Can you recall a few of the types of leakages that you learned about last year?
8 What effect does this have on the size of the economy? InjectionsInjections occur when people take actions that increase the flow of money through the circular flow diagram. What effect does this have on the size of the economy?Can you recall a few of the types of leakages that you learned about last year?
10 LeakagesSaving money is a leakage to the circular flow because it is money that could have been used to buy goods and services. Taxes are a leakage because they too represent money that might have been spent on goods and services. Instead of buying a new car, I have to pay taxes. :( Imports are also a leakage because money spent on foreign goods represent expenditures that could have been made at home in the domestic economy.
11 InjectionsInvesting money is an injection to the circular flow because it is money that is invested by firms to purchase additional capital goods.Government spending is an injection because the government uses tax money to purchase many goods and servicesExports are an injection because we are selling goods to foreigners who might have purchased domestically produced goods instead.
12 Leakages and Injections If leakages exceed injections, the economy shrinks!
13 Leakages and Injections If injections exceed leakages, the economy expands
14 National Income Accounting The Circular Flow Model shows us that the value of total output is equal to the total income generated in producing that output is equal to the expenditures made to purchase that output.National Income Accounting is the way we measure an economy's output. It allows us to:assess the performance of the economycompare one economy with anotherhelp create economic policies
15 the expenditure approach ValueWhen measuring the size of an economy, we refer to the value of the output that the economy has created. Why don't we just measure the quantity of output created?There are three ways to measure the value of aggregate output:the expenditure approachthe income method the output method
16 The Expenditure Method The expenditure approach measures the total amount of spending on final goods and services within a country during a period of time. Sound familiar?What are intermediate goods and why are they not included in this method?Can you recall the four components of the expenditure approach? They should roll right off your
17 C + I + G + (X-M)Consumption--by households of all final goods (durable and non-durable) and servicesInvestment--by firms on capital goods and all new spending on constructionGovernment--all spending on goods and services by the government at all levelsNet Exports--Value of all exports - value of all imports. May be a negative value!So C + I + G + (X-M)=GDP!
18 The Income MethodThe Income method adds up all income earned by the factors of production within a country in a given time period.Included in this is wages earned by labour, rent from land use, interest earned from capital goods, and profits earned by entrepreneurs.When we add up all these levels of income we arrive at national income, which when adjusted for depreciation and other things becomes equivalent to GDP
19 The Output MethodThe Output method measures the value of each good and service produced in the economy over a particular time period, and then adds them all up to obtain the value of output produced. This method also includes only final goods and services to avoid double counting. This method calculates output by particular sector so we know how each sector is performing.
20 Nominal vs. RealAnybody remember the difference between nominal and real figures? I bet you do (think nominal GDP vs. real GDP)
21 Nominal figures are at present day prices, not adjusted for inflation. Nominal vs. RealNominal figures are at present day prices, not adjusted for inflation.Real figures are adjusted for inflation by referring back to a base year which all following years are compared to.When we wish to compare year to year, we must use real figures to get an accurate comparison. Let's take a look out a handout so we remember how to calculate nominal GDP and real GDP.
23 Gross InvestmentOne of the components of GDP is investment, which is spending on capital goods. Some investment is on new capital goods, while other investment is to replace older capital goods. So gross investment can be divided into two parts:net investment (spending on new capital goods)depreciation (spending on worn out capital goods)Gross investment = depreciation + net investmentGross investment - depreciation = net investment
24 Two More Formulas Net Domestic Product (NDP) = C + I(n) + G + (X-M) where I(n) = new investment, soNDP= GDP - depreciation
25 GDP and GDP per capitaGDP figures tell us the size of a country's economy without really telling us anything about the amount of income received by the people of that country. For instance, India and Italy might have similar GDPs, but with India's population 15X that of Italy, the numbers are deceiving!
26 GDP per capitaGDP per capita takes a country's GDP and divides by the total population, giving us a better idea of the standard of living for the people in those countries. So if Chad and Nigeria had GDP of $500,000,000 we can calculate both GDP per capita:Nigeria GDP per capita = $500M/100M = $5Chad GDP per capita = $500M/1M = $500While these countries have the same GDP, their GDP per capita is vastly different. But this too is an imperfect statistic, isn't it?
27 GDP vs GNPGDP includes all income earned within a country's borders, regardless of who the owners of the factors of production are. Therefore, if Toyota operates a plant in the U.S.A., that would count as part of the GDP of the U.S.A.GNP includes all income earned by citizens of a country regardless of where they happen to be living or working. Therefore, the Toyota plant operating in the U.S.A. would be counted in Japan's GNP statistics.