 Circular Flow – economic model showing income and product movements  Product markets  Goods and services  Total value of output  Factor (input or resource) markets  Resources  Factor payments = Income  wages  rent  interest  profits

 Expenditures: GDP = C + I + G + Xn  C = consumer spending = f(income, interest rates)  Taxes (T)  Consumer confidence  I = Business spending on plant and equipment (Investment) = f(interest rates, expected profits): Saving is necessary  Expectations of sales and profits  Technology  Business taxes  Government sector (G): Government spending on public goods = f(votes)  Foreign sector: Net Exports (Xn) = Exports (X) – Imports (Im)= f(exchange rates)  Exchange rates: rate at which two currencies trade  Exports: goods purchased buy foreigners  Imports: goods we purchase from foreigners  Income: GDP = C + S + T

 Aggregate Demand – total dollar value of all planned expenditures  AD Curve – inverse relationship between the price level (GDP Price Deflator) and total quantity demanded  Shifts  Components  Money Supply

 Aggregate Supply – Real domestic output offered for sale by producers  AS Curve - positive relationship between the price level (GDP Price Deflator) and total quantity  Shifts  Resource prices  Productivity  Technology  Education  Legislation  Regulations  External shocks – come from outside the borders  War – security costs  OPEC Oil price increases  911  Internal shocks  Weather and natural disasters  Labor unions go on strike  Population  Immigration  Age

 Equilibrium: Total quantity demanded = Total quantity supplied  Intersection of AD and AS

 Natural (Potential) Real GDP: Economy is healthy  Full employment  Anticipated inflation  80 % Capacity

 Gaps  Contractionary Gap: Actual GDP < Natural (Potential) GDP  Sluggish economy  Unemployment  Could lead to a recession or depression  Expansionary Gap: Actual GDP > Natural (Potential) GDP  Overheating economy  Overemployment  Could lead to inflation