Transcript financial institution services

The Circular Flow model and GDP

The simplest form of circular flow
$ Consumption
Goods and Services
Producers
Households
Factors of production
Incomes $ rent wages interest profit
Circular Flow model and GDP
- Producers make goods and services
- Consumers buy this output
- There are no leakages, so payments
for goods and services by households
is equal to the value of all goods and
services produced in the economy
(GDP). This is called consumption
spending in the circular flow model.
-
Introduction of the Financial Sector
I (Investment)
d
Financial
Institutions
Ca(Payments for goods
and services)
S (savings)
c
Producers
Households
GDP = C+I+(x-m)
b
Y (Income)
An Open Economy
Financial
Institutions
Overseas
Sector
I (Investment)
d
X (Export
receipts)
f
M (Import
g
payments)
aC (consumption)
S (Savings)
c
Producers
Households
b
Y (Income)
Calculating GDP
Three methods
Income Approach
Expenditure approach
Calculating the value of goods and services by
measuring the amount households have spent on
goods and services.
Value Added approach
We will only be looking at expenditure approach
• Think back to the circular flow diagram. Which flow do
you think represents the expenditure on all goods and
services?
• Consumption spending!!
Expenditure Approach

Measures the value of all purchases of all final good and services
produced in the economy.

For households all consumption (C) is accounted for

For the firms we calculate investment (I)

Spending by government (G)

Spending by overseas countries on good and services produced
in NZ (X)

Less the spending by NZ on goods and services produced
overseas (M)
Role of the Government
Financial
Institutions
Overseas
Sector
I (Investment)
d
X (Export
receipts)
f
M (Import
g
payments)
aC (consumption)
S (Savings)
c
c
G (Government Spending)
Producers
Households
Government
tr
a
(transfers)
b
Y (Income)
T
b
(taxes)
Find GDP for the following
data using the expenditure
approache.
Values of output at each stage of Bread production
Grower
Miller
Baker
30
45
75
Intermedi ate goods
Sales
30
price
30
75
75
150
Wages
Wheat Grower Miller
Baker
Wages
30
45
75
Intermediate
goods
-
30
75
Sales price
30
75
150
•
The expenditure approach= value of the final
product = $150 million
The Circular Flow Model

Withdrawals

Injections
 Savings
 Investment
 Import
 Export
 Taxes
Payments
Receipts
 Transfers
Growth and Circular Flow

Any injections into the circular flow increase economic
growth because they increase the money supply.

They cause profits, revenue, income and employment to
increase so spending increases

This then causes business confidence to increase so
spending on capital(Investment) will also increase

This results in an increase in output so GDP increases,
causing economic growth
Introduction of the Financial Sector
Financial
Institutions
I (Investment)
d
Ca(Payments for goods
and services)
1.
S (savings)
c
Producers
Households
b
Y (Income)
1.Explain how economic activity can be measured by
the flow of payments for goods and services
2.Describe the difference between savings and
investment
3. Explain how increased investment will lead to
economic growth
4. Identify ONE limitation of the four sector circular flow
model as a tool for illustrating growth
Answers
1. The circular flow model has no leakages thus to then
measure the value of payments for goods and services
is just equal to incomes of consumers (all income earned
is spent)
2. Savings is a withdrawal as it is income not spent.
Investment is an injection into the circular flow model
and is simply creating capital resources.
3. Increased investment means increased capital
resources. These are used to produce other G&S.
Therefore increased investment results in increased
output and thus increased growth.
4. The model only shows a few flows in an economy. Thus
there are only a limited number of interactions between
the sectors