Circular Flow and GDP 2 Methods and 4

Circular Flow and GDP 2 Methods and 4 Categories of GDP

Basic Principles of Circular Flow Circular flow model is MACRO picture of economy National accounts indicate levels of economic development (flow of money) One principle that applies to BOTH – Flow of money into each sector is equal to flow of money out of that sector This also applies to the EXPANDED circular flow model.

Elements of Expanded Model Entity New information reflected Households • Part of household income is returns on private savings (stocks & bonds) • Households receive govt transfers & pay taxes Businesses • Investment spending (capital goods & inventories) and inputs make up costs • Businesses pay taxes Financial market • Households, businesses, the govt, and foreign entities buy/sell stocks & bonds Government • The govt collects taxes, provides transfers, and purchases goods & services Rest of the world • Imports/exports, foreign lending & borrowing reflect the flow of money into & out of the U. S.

Gross Domestic Product – Final Goods & Services Only includes final goods & services (direct to consumer), not intermediate (producer-to-producer sales) This is to avoid counting values two or more times

Gross Domestic Product – Two Methods 1. Value of production – To avoid duplication, each step in production only counts for “value added” – difference between sales & value of inputs purchased 2. Value of spending – Again, only counts final purchases (by consumers). Capital goods that last for years count in GDP.

Gross Domestic Product – Four Categories GDP = C + I + G + X – IM Imports are “leakage” as this is money that exits circular flow

Gross Domestic Product: What’s Included/Excluded? Included Investment spending by businesses Domestically produced final goods & services A note about inventory – Once released for sale, it is subtracted from GDP. Excluded Intermediate goods & inputs that are used up in production Used goods Stocks & bonds Imports Government transfers Nonmarket transactions