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Circular Flow Model : : Lets Simplify It

Circular Flow Model : : Lets Simplify It. Private Sector Circular Flow. Private and Public Sectors. Private sector: households, businesses, & the international sector. Household spending  “consumption”. Business spending on capital goods and inventories  “investment”.

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Circular Flow Model : : Lets Simplify It

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  1. Circular FlowModel::LetsSimplifyIt

  2. Private Sector Circular Flow

  3. Private and Public Sectors • Private sector: households, businesses, & the international sector. • Household spending “consumption”. • Business spending on capital goods and inventories“investment”. • Sales of goods and services to foreigners “exports.” Purchases from foreigners “imports.” • Public sector: government activities.

  4. Income Distribution in Market Economy What you own  What you get • Firms pay the factors of production according to their marginal products • Workers get wages equal to the marginal product of labor. • Capitalists get interest equal to the marginal product of capital. • Landlordsgetrents equal to the marginal product of land. • Entrepreneurs get profits equal to the excess of revenues over costs (payments to other factors).

  5. Household Spending and Income

  6. Private Sector Circular FlowY = Income earned from contributing to production = Wages + Interest + Rents + Profits = Receipts of FirmsY = Receipts = C + I + NX = Hshld Spending + SavingC + S = C + I + NX  S = I + NX

  7. Direction of U.S. Trade

  8. Open Economy Circular Flow

  9. The Government’s Role Correct for: • Imperfect Information • Externalities • Public Goods • Lack of Competition • Business Cycles

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

  11. Macroeconomic PolicyMacro Stability: A Public Good • Monetary Policy • Policies that influence money and credit (money supply and interest rates). • In the U.S., the Federal Reserve Board (“the Fed”) is responsible for this. • Fiscal Policy • Policies that control government spending and taxation. • In the U.S. federal government, Congress enacts these policies and the President signs them into law.

  12. Federal, State, and Local Government Expenditures for Goods and Services

  13. U.S. Federal Budget Deficits

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