302_Chapter2 - CHAPTER 2 I Circular Flow Model of the...

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CHAPTER 2 I. Circular Flow Model of the Macroeconomy A. Flow versus stock 1. Flows are measured as rates per unit of time a. Production, expenditures, investment, and income are all flows (i.e., measured over time) b. Economic activity (production, income, etc.) is measured annually 2. Stocks are measured at a point in time a. Wealth, capital base, and the national debt are all stocks (i.e., a specific value in time) b. Stocks are linked to flows (the change in a stock over time is a flow) B. Circular Flow total income created (Y) is identical to total expenditure on final product (E) Say’s Law C. Simple economy (no saving, no govt., and no foreign sector) 1. Firms generate national product by hiring factors of production from households 2. Households receive income from supplying factors of production 3. No saving all income is consumption expenditure on national product 4. Simple economy expenditure = income = production D. Simple capitalist economy (saving but no govt. or foreign sector) 1. Income (Y) = Consumption (C) + Saving (S) or S = Y - C 2. Saving is a leakage out of consumption 3. Private saving = personal saving (households) + firm saving (depreciation + retained earnings) 4. Public saves (delays cons.) because firms need to borrow to build capital equipment required to produce national product 5. Saving flows into capital markets where borrowers pay interest to use funds for investment expenditures 6. Expenditure (E) = Consumption (C) + Total Investment (I) a. Total investment = planned investment (i p ) + unplanned inventory invest. (i u ) b . i u is unsold national product (unplanned inventory) 7. Investment is an injection into the expenditure flow
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2 8. Equilibrium production requires leakages to equal injections 9. Circular flow saving leakage out of the Domestic Income flow is offset by an injection of investment (nonconsumption) expenditures E. Economy with Government and Foreign Sector 1. Expenditures now include govt. purchases of goods and services (G) , exports (EX) , and imports (IM) : E = C + I + G + EX - IM 2. With a govt. sector, Y is reduced by taxes (R) and increased by income transfers (F) 3. Net taxes (T) : T = R - F (transfers negative tax) 4. Domestic income account: Y = C + S + T 5. Leakages from Y (and expenditures on domestic product) a. Net taxes (income flow to govt.) b. Imports (expend. flow to foreign econ.) 6. Injections into domestic expenditure flow a. Govt. purchases (excludes transfers) b. Exports (expend. flow from foreign econ) 7. Equilibrium in circular flow a . Y = E b . C + S + T = C + I + G + EX - IM c . S + T + IM = I + G + EX leakages are exactly offset by injections F. Domestic income account relationships 1. S + T + IM = I + G + EX (S - I) + (T - G) + (IM - EX) = 0
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This note was uploaded on 04/10/2008 for the course ECON 302 taught by Professor Adamson during the Spring '08 term at SD State.

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302_Chapter2 - CHAPTER 2 I Circular Flow Model of the...

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