11

CircularCircular Flow FlowModelModel

::::

LetsLetsSimplifySimplify

ItIt

22

Private Sector Circular FlowPrivate Sector Circular Flow

33

Private and Public SectorsPrivate and Public SectorsPrivate sector:Private sector: households, households, businesses, & the international sector.businesses, & the international sector.

Household spending Household spending “consumption”.“consumption”.Business spending on Business spending on capital goods capital goods and inventoriesand inventories “investment”.“investment”. Sales of goods and services to Sales of goods and services to foreigners foreigners “exports.”“exports.”

Purchases from foreigners Purchases from foreigners “imports.”“imports.”Public sector:Public sector: government activities. government activities.

44

Income Distribution in Market EconomyIncome Distribution in Market EconomyWhat you own What you own What you get What you get

Firms pay the Firms pay the factors of productionfactors of production according to their according to their marginal productsmarginal products– WorkersWorkers get get wageswages equal to the marginal equal to the marginal

product of product of laborlabor..– CapitalistsCapitalists get get interestinterest equal to the equal to the

marginal product of marginal product of capitalcapital..– LandlordsLandlords getget rentsrents equal to the marginal equal to the marginal

product of product of landland..– EntrepreneursEntrepreneurs get get profitsprofits equal to the equal to the

excess of revenues over costs (payments excess of revenues over costs (payments to other factors).to other factors).

55

Household Household Spending Spending

and and IncomeIncome

66

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

77

Direction of U.S. TradeDirection of U.S. Trade

88

Open Open Economy Economy CircularCircular

Flow Flow

99

The Government’s RoleThe Government’s Role

Imperfect Information Externalities Public Goods Lack of Competition Business Cycles

Correct for:

1010

Consumption by one person does not diminish the quantity or quality available to others.Public goods can be jointly consumedPublic 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.

Public GoodsPublic Goods

1111

Macroeconomic PolicyMacroeconomic PolicyMacro Stability: A Public GoodMacro Stability: A Public Good

Monetary PolicyMonetary Policy– Policies that influence Policies that influence money and creditmoney and credit

(money supply and interest rates). (money supply and interest rates). – In the U.S., the Federal Reserve Board In the U.S., the Federal Reserve Board

(“(“the Fedthe Fed”) is responsible for this.”) is responsible for this.Fiscal PolicyFiscal Policy– Policies that control government Policies that control government

spending and taxationspending and taxation. . – In the U.S. federal government, In the U.S. federal government,

CongressCongress enacts these policies and the enacts these policies and the PresidentPresident signs them into law. signs them into law.

1212

Federal, State, and Federal, State, and Local Government Local Government Expenditures for Expenditures for

Goods and Goods and ServicesServices

1313

U.S. U.S. Federal Federal Budget Budget DeficitsDeficits