Income and Spending: The Circular Flow

1
Income and Spending The Circular Flow

• Ways to Measure GDP
• Circular Flow

2
Three Ways to Measure GDP

• (1) The Product Approach.
• GDP Total Output of Goods and Services
• (this is the definition of GDP we discussed
  earlier)
• (2) The Income Approach
• GDP Total Income of All Domestic
  Residents
• (recall Bakery Example)

3
Some Definitions

• (i) Total Income Wages/Salaries Profits
  Interest Rental
• (ii) GDP Total Value Added Sales Revenue
  Costs for Intermediate Goods.
• (iii) Profits Sales Revenue Costs of
  Intermediate Goods Other Costs
• (iv) Other Costs Wages/Salaries Interest
  Rental

4

• (iii) and (ii) says
• Profits Total Value Added Other Costs
• GDP Other Costs
• gt GDP Profits Other Costs
• Profits Wages/Salaries Interest
  Rental
• Total Income

5

• Other Measures of Income
• GNP GDP Net Income Earned Abroad
• Net National Product (NNP) GNP
  Depreciation Investment
• National Income (NI) NNP Indirect Business
  Taxes

6

• (3) The Expenditures Approach
• GDP Total Expenditures on Final Goods
• Four Major Categories of Expenditures
• (1) Consumption (C) Household
• Spending on Goods and Services
• (2) Investment (I) Business Spending on
  Productive Capital Goods
• (3 ) Government Purchases (G) Government
  purchases of goods and services
• (4) Net Exports (NX) Exports (X) Imports (M)

7

• Income-Spending Identity
• GDP
• Total Domestic Income Total Expenditures
• GDP Y C I G NX

8
The Circular Flow

• Four Sectors of the Economy
• (1) Households
• (2) Firms
• (3) Government
• (4) Foreigners
• Capital Markets channel funds from lenders to
  borrowers. Examples Banks, Stock/Bond Markets.

9

• Households Consumers/Workers (everyone)
• Earns Income or GDP Y
• Spends on Consumption C
• Pays Taxes (net of transfer payments) T
• Disposable Income (DI) Y T
• Saving (S) DI - C

10

• Business Firms
• Produces GDP or Y C I G NX
• Borrows from capital market to buy
  investment goods (I).
• Government
• Collects Net Taxes T
• Spends on Goods and Services G
• Borrows Federal Budget Deficit G -T

11

• The Federal Budget Deficit is the excess of
  government spending over tax revenues or
  government borrowing in a given year.
• T G gt 0 gt Budget Surplus
• T G lt 0 gt Budget Deficit
• The National Debt is the total outstanding debt
  of the Federal government.

12

• Foreigners rest of the world
• Spends on U.S. Exports (X)
• Sells Imports (M)
• Net Exports X M NX
• NX gt 0 gt Trade Surplus (net foreign
  lender)
• NX lt 0 gt Trade Deficit (net foreign
  borrower)

13

• Some Important Relationships
• Y C I G NX
• S I Budget Deficit NX
• I (G T) NX