1. A SIMPLE ECONOMY – the 1800s SECTORSUSE NOWIGNORE FOR NOW Households Businesses Government Foreign Households Businesses Government Foreign TYPES OF SPENDINGUSE NOWIGNORE FOR NOW Consumption (domestic) Investment Government Purchases Exports Consumption Investment Government Purchases Exports USES OF INCOMEUSE NOWIGNORE FOR NOW Consumption (domestic) Saving Taxes Imports Consumption Saving Taxes Imports

2. H&B THE SIMPLE CIRCULAR FLOW DIAGRAM (MODEL) A simple economy has two main parts: 1.H&B, People – Households and Businesses -- who: a.Spend income b.Earn income 2. The Product Market (PrM) -- all the stores and factories where: a. goods and services are produced and sold People Spend b. people are employed People earn The income from producing and selling goods is paid to the owners of the factors of production (FOPs) as wages, rent, interest and profit. The arrows show the direction in which the money moves. The income received by the FOPs is then spent in the Prm, and the money goes around and around – hence the name “the Circular Flow.” PrM Spending Income earned Income spent

3. I PrM H&B X C Y S THE SIMPLE CF MODEL In the simplest economy there are two uses of Income (Y). Income is either Consumed or Saved. Y = C + S X = C + I In the simplest economy there are two types of Spending (X): Consumption spending by households (C) and Investment spending by businesses on capital goods (I) Let’s add more detail to our picture of a simple economy and describe the picture by two equations. These two equations will get more complicated as we go

4. WHERE DID THE MONEY FOR Investment COME FROM?

5. I PrM H&B X C Y CrM S MODEL 0 – the Credit Market The purpose of the Credit Market (CrM) is to ensure that all income is spent by someone. Any income (Y) not spent by those who receive it is saved, put into the Crm, loaned to a business who will use it to buy capital – i.e. will invest the savings The Credit Market (CrM) can, for now, be though of as “Banks” though it includes all manner of other financial institutions such as the stock market.