The Circular Flow of Income

1
The Circular Flow of Income
2
The circular flow of income
Firms
Households
3
THE CIRCULAR FLOW OF INCOME

• Withdrawals
• net saving
• net taxes
• import expenditure
• Injections
• investment
• government expenditure
• export expenditure

4
The circular flow of income
INJECTIONS
Consumption of domestically produced goods and
services (Cd)
Factor payments
WITHDRAWALS
5
THE CIRCULAR FLOW OF INCOME

• The relationship between injections and
  withdrawals
• the links between them
• planned injections may not equal planned
  withdrawals
• Equilibrium in the circular flow
• The circular flow and the four macroeconomic
  objectives

6
The National Economy

• Measuring National Income

7
MEASURING NATIONAL INCOME

• The three ways of measuring GDP
• the production method
• the income method
• the expenditure method

8
The circular flow of national income and
expenditure
9
The circular flow of national income and
expenditure
(1) Production
(2) Incomes
(3) Expenditure
10
MEASURING NATIONAL INCOME

• The product method
• the problem of double counting
• the measuring of value added
• gross value added (GVA)
• some qualifications
• stocks
• government services
• ownership of dwellings
• taxes and subsidies on products

11
UK GVA (product-based measure) 2001
0.9 4.7 17.5 5.4 12.2 3.4 8.0 0.8 24.0 4.8
13.0 5.2 100.0
Agriculture, forestry and fishing 8 241
m Mining, energy and water supply 41 378
m Manufacturing 153 132 m Construction 47
327 m Wholesale and retail trade repairs 106
766 m Hotels and restaurants 29 359m Transport
and communication 70 252 m Banking, finance,
insurance, etc. 6 667 m Letting of property
209 839 m Public administration and defence
42 096 m Education, health and social work
114 069 m Other services 45 101 m Total GVA
874 227 m
12
UK GVA (product-based measure) 2001
0.9 4.7 17.5 5.4 12.2 3.4 8.0 0.8 24.0 4.8
13.0 5.2 100.0
Agriculture, forestry and fishing 8 241
m Mining, energy and water supply 41 378
m Manufacturing 153 132 m Construction 47
327 m Wholesale and retail trade repairs 106
766 m Hotels and restaurants 29 359m Transport
and communication 70 252 m Banking, finance,
insurance, etc. 6 667 m Letting of property
209 839 m Public administration and defence
42 096 m Education, health and social work
114 069 m Other services 45 101 m Total GVA
874 227 m
13
UK GVA (product-based measure) 2001
0.9 4.7 17.5 5.4 12.2 3.4 8.0 0.8 24.0 4.8
13.0 5.2 100.0
Agriculture, forestry and fishing 8 241
m Mining, energy and water supply 41 378
m Manufacturing 153 132 m Construction 47
327 m Wholesale and retail trade repairs 106
766 m Hotels and restaurants 29 359m Transport
and communication 70 252 m Banking, finance,
insurance, etc. 6 667 m Letting of property
209 839 m Public administration and defence
42 096 m Education, health and social work
114 069 m Other services 45 101 m Total GVA
874 227 m
Percentage of GVA
14
UK GVA by category of income 2001
63.6 27.3 6.9 2.2 100.0
Compensation of employees (wages and
salaries) 556 371 m Operating
surplus (gross profit, rent and interest of
firms government and other institutions) 238 625
m Mixed incomes 60 073 m Tax less subsidies on
production (other than those on products)
plus statistical discrepancy 19 158m Total GVA
874 227m
15
UK GVA by category of income 2001
63.6 27.3 6.9 2.2 100.0
Compensation of employees (wages and
salaries) 556 371 m Operating
surplus (gross profit, rent and interest of
firms government and other institutions) 238 625
m Mixed incomes 60 073 m Tax less subsidies on
production (other than those on products)
plus statistical discrepancy 19 158m Total GVA
874 227m
16
UK GVA by category of income 2001
63.6 27.3 6.9 2.2 100.0
Compensation of employees (wages and
salaries) 556 371 m Operating
surplus (gross profit, rent and interest of
firms government and other institutions) 238 625
m Mixed incomes 60 073 m Tax less subsidies on
production (other than those on products)
plus statistical discrepancy 19 158m Total GVA
874 227m
Percentage of GVA
17
UK GDP (product-based measure) 2001
GVA (gross value added at basic prices) 874
227m plus Taxes on products 120 499m less
Subsidies on products 6 712m GDP (at
market prices) 988 014m
18
UK GDP (product-based measure) 2001
GVA (gross value added at basic prices) 874
227m plus Taxes on products 120 499m less
Subsidies on products 6 712m GDP (at
market prices) 988 014m
19
UK GDP (product-based measure) 2001
GVA (gross value added at basic prices) 874
227m plus Taxes on products 120 499m less
Subsidies on products 6 712m GDP (at
market prices) 988 014m
20
UK GDP (product-based measure) 2001
GVA (gross value added at basic prices) 874
227m plus Taxes on products 120 499m less
Subsidies on products 6 712m GDP (at
market prices) 988 014m
21
UK GDP by category of expenditure, GNI and NNI
2001
million Consumption expenditure of households
and NPISH (C) 655 265 Government final
consumption (G) 190 663 Gross capital formation
(I) 164 048 Exports of goods and services (X) 268
451 less Imports of goods and services (M) ?290
912 Statistical discrepancy 499 Gross domestic
product (GDP) (at market prices) 988 014
22
UK GDP by category of expenditure, GNI and NNI
2001
million Consumption expenditure of households
and NPISH (C) 655 265 Government final
consumption (G) 190 663 Gross capital formation
(I) 164 048 Exports of goods and services (X) 268
451 less Imports of goods and services (M) ?290
912 Statistical discrepancy 499 Gross domestic
product (GDP) (at market prices) 988 014 plus Net
income from abroad 5 756 Gross national income
(GNI) 993 770
23
UK GDP by category of expenditure, GNI and NNI
2001
million Consumption expenditure of households
and NPISH (C) 655 265 Government final
consumption (G) 190 663 Gross capital formation
(I) 164 048 Exports of goods and services (X) 268
451 less Imports of goods and services (M) ?290
912 Statistical discrepancy 499 Gross domestic
product (GDP) (at market prices) 988 014 plus Net
income from abroad 5 756 Gross national income
(GNI) 993 770 less Capital consumption
(depreciation) -111 275 Net national income
(NNI) 882 495
24
Macroeconomic equilibrium

• In a very simple economy, it must be that
• Y C I
• Y C S
• C S C I i.e. S I
• Actual savings are by definition equal to actual
  investment by it is by no means guaranteed that
  planned savings match planned investments
• The saving and investment decisions are taken by
  various groups, and if there is a mismatch,
  instability may be generated

25
All income is consumed GNI GNP 100
Consumption 100
Households
Firms
GNI 100
What happens if households want to savepart of
their income (S 10) ?
26
Planned savings equal planned investments
Consumption 90
Households
Firms
S10
I10
Capital-market
GNI 100
Savings are a leakage (withdrawal) from
thecircular flow
27
Households want to save more
Consumption 80
Households
Firms
S20
I10
Capital-market
GNI 100
There is an unplanned increase in
inventoriessince households save more
28
Households want to save more
Consumption 40
Households
Firms
S10
I10
Capital-market
GNI 50
The equilibrium level of income is reducedas
firms cut back on production.