2 Methods and 4 Categories of GDP
Basic Principles of
Circular Flow

 Circular flow model is MACRO picture of economy
 National accounts indicate levels of economic
development (flow of money)
 One principle that applies to BOTH – Flow of money
into each sector is equal to flow of money out of that
sector
This also applies to the EXPANDED circular flow model.
Elements of Expanded Model

Entity
New information reflected
Households
• Part of household income is returns on private
savings (stocks & bonds)
• Households receive govt transfers & pay taxes
Businesses
• Investment spending (capital goods &
inventories) and inputs make up costs
• Businesses pay taxes
Financial market
• Households, businesses, the govt, and foreign
entities buy/sell stocks & bonds
Government
• The govt collects taxes, provides transfers, and
purchases goods & services
Rest of the world
• Imports/exports, foreign lending & borrowing
reflect the flow of money into & out of the U.S.
Gross Domestic Product –
Final Goods & Services

 Only includes final goods & services (direct to
consumer), not intermediate (producer-to-producer
sales)
 This is to avoid counting values two or more times
Gross Domestic Product –
Two Methods

1. Value of production – To avoid duplication, each
step in production only counts for “value added” –
difference between sales & value of inputs
purchased
2. Value of spending – Again, only counts final
purchases (by consumers). Capital goods that last
for years count in GDP.
Gross Domestic Product –
Four Categories

 GDP = C + I + G + X – IM
 Imports are “leakage” as this is money that exits
circular flow
Gross Domestic Product:
What’s Included/Excluded?

Included
 Investment spending
by businesses
 Domestically produced
final goods & services
A note about inventory –
Once released for sale, it is
subtracted from GDP.
Excluded
 Intermediate goods &
inputs that are used up
in production
 Used goods
 Stocks & bonds
 Imports
 Government transfers
 Nonmarket
transactions