bASIC CONCEPTS AND CIRCULAR Flow of Income

bASIC CONCEPTS AND CIRCULAR Flow of Income - Transcript

MACRO 1 A brief introduction some basic concepts and the Circular Flow of Income
Chapter 1 of G rtner

INCOME
The most important measure in terms of the performance of an economy is income normally per capita So it seems natural that the main focus of macroeconomics is on income generation Incomes are paid out to factors of production
Factors of production include labour capital etc

But firms may not use all available factors unemployment or slack Or people may not want to buy all that is produced demand may fall short of output excess supply Both of these imply wasted resources Obliviously we want our economy to work so that we maximize our income from our scarce resources

Macroeconomic Models
Macroeconomics makes use of simplified models normally series of equations in order to provide us with estimates of how different government policy decisions will impact on parts of the economy In order to make the models simple we often need to make a number of assumptions While these assumptions may not always be completely true we hope that the model still provides us with good estimates Obliviously if the assumptions are wildly untrue then perhaps we need to make our model more complicated to get better estimates But complicated models are often hard to understand and even harder to explain to policy makers So there is a balance So let s recap on the setting up these models

Circular flow of income households furnish firms with factors of production receive goods and services produced by firms

The outer circle shows that the inner real flow of labour and goods is financed by a monetary flow of income payments from firms to households which in turn flows back to the firms as the households spending on the firms goods

The national income accounts
One person s spending is another person s income All spending must add up to the sum of all incomes thus Total production or aggregate output the value of all goods and services produced by firms may be measured either by
adding up all incomes the income approach or by adding up all expenditures the expenditure approach

Basically we use money pounds as the case may be here as a means to distribute goods to those households who want them the most and money to pay households for their labour

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Leakages and Injections
Injections demand from outside the circular flow Leakages incomes received by households may
not arrive at firms because People save Savings consumption falls short of what they received as income Governments levy taxes Taxes part of income is prevented from returning into demand People buy foreign goods IMports incomes earned at home is spent on goods that are produced abroad may be directed towards domestic output Firms invest Investment these investments are typically financed via credit from financial sector from domestic savings foreign saving government saving etc Government spending on consumption infrastructure roads education health etc Foreigners buy our goods EXports goods flow out of the economy and income flows in

Expenditure on Domestic goods

Total expenditure total income if the sum of all leakages equals the sum of all injections If spending output firms will stock up inventories But if we consider that investment not only includes new machinery but also inventories assume that the firms can sell the goods later Hence leakages injections always balance

S I T G IM EX 0

S T IM I G EX

I S G T EX IM 0 or S I T G IM EX 0
S I domestic private net savings T G public government net savings budget surplus IM EX net imports trade balance In most countries Governments run sizeable budget deficits Private saving exceeds investment hence goes to finance govt s deficit There is either a trade surplus or deficit

2002 data as a of GDP

Table 1 2 The circular flow identity in numbers
Source Eurostat IMF International Financial Statistics

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Government Budget Balance of Payment
Government Budget details G and T show how they are financed G T DPS DCB where D ps change in debt held by private sector and D B the change in debt by the Central Bank C So in our model we are bringing in another player the Central Bank who can also finance government debt

BoP details IM EX shows how they are financed Three major accounts Current Account CA EX IM flows of goods services Capital Account CP F F net foreign assets registers net demand for domestic currency stemming from net sales of domestic assets to foreigners Official Reserves Account OR RES RES foreign currency reserves e g Central Bank sells reserves of AUS in order to buy pounds tracks involvement of CB in foreign exchange market

EX IM F RES
BoP how trade imbalance is financed

2002 Data in millions of US dollars

If EX IM There is excess demand for domestic currency other countries needed to buy our exports more than we wanted their imports but they will have to pay somehow for them This can be balanced by Either Us accepting i e buying foreign debt titles foreign capital which raises F Or by the CB supplying the required domestic currency selling the excess pounds i e by increasing the stock of foreign reserves buying the foreign currency which raises RES
Table 1 3 The balance of payments accounts
Source IMF IFS

Note CA CP OR does not hold in the data because of omissions and errors in collection

Central Bank CB does not pump money into the economy CB s own liability is the currency it puts into circulation Money Supply CB s assets Govt s debt DCB Currency reserves M DCB RES

Summary
So far we have considered a number of key players in the economy and some stylised facts about general constraints in our model But We have incorporated little about economic relationships The model does not inform us of the consequences of raising taxes only that it must but off set with changes in other leakages and injections Later on we will start to build into our model these economic relationships between sectors

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