Circular Flow Model : : Lets Simplify It

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Circular FlowModelLetsSimplifyIt
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Private Sector Circular Flow
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Private and Public Sectors

• Private sector households, businesses, the
  international sector.
• Household spending ?consumption.
• Business spending on capital goods and
  inventories ? investment.
• Sales of goods and services to foreigners
  ?exports.
• Purchases from foreigners ? imports.
• Public sector government activities.

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Income Distribution in Market Economy

• What you own ? What you get
• Firms pay the factors of production according to
  their marginal products
• Workers get wages equal to the marginal product
  of labor.
• Capitalists get interest equal to the marginal
  product of capital.
• Landlords get rents equal to the marginal product
  of land.
• Entrepreneurs get profits equal to the excess of
  revenues over costs (payments to other factors).

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Household Spending and Income
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Private Sector Circular FlowY Income earned
from contributing to production Wages
Interest Rents Profits Receipts of FirmsY
Receipts C I NX Hshld Spending
Saving C S C I NX ? S
I NX
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Direction of U.S. Trade
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Open Economy Circular Flow
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The Governments Role
Correct for

• Imperfect Information
• Externalities
• Public Goods
• Lack of Competition
• Business Cycles

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Public Goods

• Consumption by one person does not diminish the
  quantity or quality available to others.
• Public goods can be jointly consumed
• Public goods are non-excludable
• No one has a private property right to a public
  good.
• Everybody has incentive to be a free rider
• When everyone free rides, too little (or none) is
  produced.

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Macroeconomic PolicyMacro Stability A Public
Good

• Monetary Policy
• Policies that influence money and credit (money
  supply and interest rates).
• In the U.S., the Federal Reserve Board (the
  Fed) is responsible for this.
• Fiscal Policy
• Policies that control government spending and
  taxation.
• In the U.S. federal government, Congress enacts
  these policies and the President signs them into
  law.

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Federal, State, and Local Government Expenditures
for Goods and Services
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U.S. Federal Budget Deficits