Circular Flow of Income

AVBC
Circular flow of Income
• Flow of money from you to the seller and a flow of goods/services
from the seller to you
• As individuals and firms buy and sell goods and services, money flows
among the different sectors of the economy
Simplest version of the circular flow

Consumption/Spending

Households Firms

Wage/Income
Complete Circular Flow
The Firm Sector
• The flows in and out the firm sector of an economy must be balance
• The total flow of money from the firm sector measures the total value
of production in the economy. The total flow of dollars into the firm
sector equals total expenditures on GDP which is divided into 4
categories
• Consumption
• Investment
• Government Purchases
• Net Exports
The Firm Sector
• The flows in and out the firm sector of an economy must be balance
• The total flow of money from the firm sector measures the total value
of production in the economy. The total flow of dollars into the firm
sector equals total expenditures on GDP which is divided into 4
categories
• Consumption – Total expenditures by households on final goods and services
• Investment
• Government Purchases
• Net Exports
The Firm Sector
• The flows in and out the firm sector of an economy must be balance
• The total flow of money from the firm sector measures the total value
of production in the economy. The total flow of dollars into the firm
sector equals total expenditures on GDP which is divided into 4
categories
• Consumption
• Investment – Purchase of goods and services that help to produce output in
the future
• Government Purchases
• Net Exports
The Firm Sector
• The flows in and out the firm sector of an economy must be balance
• The total flow of money from the firm sector measures the total value
of production in the economy. The total flow of dollars into the firm
sector equals total expenditures on GDP which is divided into 4
categories
• Consumption
• Investment
• Government Purchases – All purchases of goods and services by the
government
• Net Exports
The Firm Sector
• The flows in and out the firm sector of an economy must be balance
• The total flow of money from the firm sector measures the total value
of production in the economy. The total flow of dollars into the firm
sector equals total expenditures on GDP which is divided into 4
categories
• Consumption
• Investment
• Government Purchases
• Net Exports – Difference between exports and imports: measures the total
expenditure flows associated with the rest of the world
The Household Sector
• Household receives income from firms
• Also receives money from the government (transfers) and must pay
money to the government (taxes)
• Spend some of disposable income and save the rest
• Households take savings to financial markets to purchase interest-
bearing assets
The Government Sector
• Key functions
• Purchases goods and services
• Collects revenues through personal and corporate taxes
• Gives transfers to households
• Amount collected in taxes is not equal to amount it pays out for
government purchases
• Government spends more than it gathers in taxes, then it must
borrow from the financial markets to make up the shortfall
The Financial Sector
• It is at the heart of the circular flow
• It summarizes behavior of banks and other financial institutions
• Shows that the savings of households provide the source of
investment funds for firms
The Foreign Sector
• Imports and exports
• Flow is shown as “borrowing from abroad=imports-exports”
• If we export more than we import then we are lending to the rest of
the world and there is flow of money from the financial markets to
the rest of the world
END