The circular flow of income

household

A household is an individual or group of people who live at the same address. Households own a factor services which, In a market economy, they hire out to firms.

are economic agents

Agents is a term used to describe households and firms

when the rate of injections = the rate of withdrawals

An economy is in equilibrium

discretionary income

Discretionary income is income left from disposable income after paying for essentials such as food and housing costs. Discretionary income can be saved or spent on non-essentials such as holidays, eating out and going to the cinema or consumer goods.

flow

Flow refers to an amount per period of time. There is the flow of income earned by households, and the flow of expenditures on the purchase of the output of firms. This flow is measured over a given time period usually one year, using money. The total amount of money earned is called gross domestic product.

monetatry policy committee of the bank of England (MPC)

a group of 9 people which meets at least once a month to set the rate at which banks borrow from the bank of England in a crisis

nominal income

income expressed in money terms. It is income measured in current dollars. In simple terms it is the dollar amount written on your pay check. Nominal income has nothing to do with the buying power of my income. Real income is nominal income adjusted for inflation.

resources

materials found in the earth that people need and value

goods

materials that satisfy human wants and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods that are tangible property, and services, which are non-Physical.

macroeconomic equilibrium

occurs when in a given time period, eg a year, the value of injections equals value of leakages.

consumption

spending by households on goods and services, with the exception of purchases of new housing

real income

the income of an individual or group after taking into consideration the effects of inflation on purchasing power. For example, if you receive a 2% salary increase over the previous year and inflation for the year is 1%, then your real income only increases by 1%.

interest rates

the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.

aggregate demand

the total demand for final goods and services in an economy at a given time. It specifies the amounts of goods and services that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country.

Income induced

will increase as income increases and decrease as income decreases.

aggregate demand equation

C + I + G + (X − M) C - consumption I - investment G - government spending X - exports M - imports

circular flow

The circular flow of income and spending shows connections between different sectors of an economy: - It shows flows of goods and services and factors of production between firms and households - The circular flow shows how national income or Gross Domestic Product is calculated businesses produce goods and services and in the process of doing so, incomes are generated for factors of production (land, labour, capital and enterprise) - for example wages and salaries going to people in work.

circular flow of income explination

The circular flow of income illustrates economic activity between four sectors in an economy over a given time period eg one year.

other source of household income

The government pays some households benefits eg jobseeker allowance. This unearned income is called transfer payments.

Factor incomes

factors of production earn an income which contributes to national income. Land receives rent, human capital receives a wage, real capital receives a rate of return, and enterprise receives a profit. Members of households pay for goods and services they consume with the income they receive from selling their factor in the relevant market.

leakages

increases in savings, taxes or imports so reducing the circular flow of income and leading to a multiplied contraction of production (output).

level of national income - falling

the sum of withdrawals > the sum of injections

hot money

Hot money flows refer to capital flows moving to countries with higher interest rates and/or expected changes in exchange

How households earn income

Households earn income by hiring out their factor services to firms. Workers receive wages or salaries; lending out capital earns interest; entrepreneurs receive profits; landlords are paid rent.

national income

the total amount of money earned within a country.

disposable income

Disposable income is net household income left after deducting direct taxes such as income tax, and adding state benefits such as child benefit.

Stock

a quantity measured at a particular point in time.

Investment

spending by firms on buildings, machinery and improving the skills of the labour force.

Problems of hot money flows

- Hot money flows can be destabilising. A rapid rise in the currency can harm a countries exports because exports become more expensive. - Hot money flows can create excess liquidity fuelling a future asset boom and creating more long-term problems.

injections into the circular flow of income

Injections occur when firms receive income from selling their output to other firms investment (I), the government, (G) or overseas through exports (X)

leakages from the circular flow of income

Leakages occur when households put some income aside in savings (S); to pay government tax (T); Buy foreign made products: imports (M)

credit crunch

a sudden reduction in the ability to gain loans to finance borrowing, as lenders lose their nerve in a tight money market. the effects of the tight borrowing makes investment more difficult and interest rates in commercial markets tend to rise

Savings

a withdrawal from the circular flow. The portion of current income not spent on consumption

service

an economic activity where an immaterial exchange of value occurs. When a service such as labor is performed the buyer does not take exclusive ownership of that which is purchased, unless agreed upon by buyer and seller.

foreign direct investment

an investment made by a firm or individual in one country into business interests located in another country. Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign business assets, including establishing ownership or controlling interest in a foreign company. Foreign direct investments are distinguished from portfolio investments in which an investor merely purchases equities of foreign-based companies.

Withdrawals

any money not passed on in the circular flow and has the effect of reducing national income/output/expenditure.

macroeconomics

studies aggregate or total behaviour ie how all consumers, firms the government and overseas economic agents interact. Microeconomics considers how individual firms and consumers behave in individual markets.

multiplier

the amount by by which a change in an injection such as investments impacts on national income

Net government spending

the difference between government spending and taxation

income

the financial gain (earned or unearned) accruing over a given period of time

the public sector in the circular flow of income - Including international trade

the model must be adjusted to include international trade. Countries that trade are called 'open' economies, the households of an open economy will spend some of their income on goods from abroad, called imports (M), and this is withdrawn from the circular flow. Foreign consumers and firms will, however, also wish to buy domestic products, called exports (X), and this is an injection into the circular flow.

human capital

the skills and ability of the labour force

level of national income - rising

the sum of injections > the sum of withdrawals

aggregate supply

the total supply of goods and services available to a particular market from producers.

How household and firm sectors interact

- Households receive payments (income) for hiring out their services (eg labour) and then buy the output of firms (consumption) - Firms hire land labour and capital (resources) owned by households to produce goods and services (products) for which they pay wages rent etc (income). Firms receive payment (consumption) when products are sold.

Injections

- investment (I) - capital spending by firms, i.e. investment expenditure (I) e.g. on new technology - government spending (G) - The government, i.e. government expenditure (G) e.g. on the NHS or defence - exports (M) - Overseas consumers buying UK goods and service, i.e. UK export expenditure (X)

Leakages (withdrawals) from the circular flow

- saving (s) - Put aside for future spending, i.e. savings (S) in banks accounts and other types of deposit - imports (m) - Spent on foreign-made goods and services, i.e. imports (M) which flow into the economy - taxation (t) - Paid to the government in taxation (T) e.g. income tax and national insurance

the public sector in the circular flow of income

In a mixed economy with a government, the simple model must be adjusted to include the public sector. Therefore, as well as save, households are also likely to pay taxes (T) to the government (G), and further income is withdrawn out of the circular flow of income. Government injects income back into the economy by spending (G) on public and merit goods like defence and policing, education, and healthcare, and also on support for the poor and those unable to work.

government sector

In macroeconomics the focus is on the role of government in collecting taxes (T) to fund spending on public services (G), and transfer payments

Injection

additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.

firm

firm is an organisation that hires and organises resources to make products

circular flow of income - diagram

The circular flow of income shows the flow of money from economic activity between households and firms. Households receive payments for their services (income) and use this money to buy the output of firms (consumption).

examples of government spending

Government (G) spending is state expenditure on public services eg NHS doctors' salaries & state schools.

What the international sector is

Domestic economic activity in an open economy results in imports and exports. The international sector is made up of: - Domestic purchase of overseas made products: imports (M) - Overseas purchase of UK made products: exports (X)

circular flow of income

The factor owners spend this income on goods which leads to a circular flow of income. This basic circular flow of income model consists of six assumptions: The economy consists of two sectors: households and firms. Households spend all of their income (Y) on goods and services or consumption (C).

government

The government is the body that passes and enforces laws, collects taxes to finance public expenditure, and intervenes in the free market to change behaviour.

transfer payments

Transfer payments are unearned benefits paid out to households by the government e.g. unemployment, disability and child allowances

the difference between normative income and real income

it can be seen that while income expressed in money terms. It is income measured in current dollars. In simple terms it is the dollar amount written on your pay check. Nominal income has nothing to do with the buying power of my income. Real income is nominal income adjusted for inflation, real income can be seen to refer to the income of an individual or group after taking into consideration the effects of inflation on purchasing power.