Module 10: Circular Flow Model & GDP
The National Accounts – National Income accounting basically keeps track of the
flows of income and expenditures in the economy over a period of time. Much like an
income statement for a business firm.
The Circular Flow Model – (Basic version, no Gov. or foreign sector) People buy
“stuff” and businesses provide the “stuff” in the G & S (goods & sevices) market. In the
factor market, people provide the factors of production (labor, capital, resources, land,
etc.) that the businesses buy.
Expanded Circular Flow Model – (A little more complicated version p. 104) This now
includes government, the financial markets, & the foreign markets as well.
Let’s take a look…
Gross Domestic Product – (GDP) The total market value of all final goods and services
produced within a country in one year.
There are 3 different ways to get this number but we are only going to focus on # 3.
You should understand what the other 2 are but we will not use them.
1. Value of Production – at each stage of production, value is added.
2. Factor Income Earned – all the total factors of production added up.
3. Spending on Domestically Produced Final G & S –
GDP = C + I + G + (X – IM)
C – personal Consumption expenditures – includes durable goods, non-durable
goods & services
I - domestic Investment –
a. all final purchases of machinery, equipment, and tools by businesses.
b. all construction (apartments or a Target Superstore)
c. Changes in business inventory.
G – Government Purchases – consumer & capital goods (fed, state, & local) as well
as labor.
(X – IM) Net Exports –(also known as Xn) exports minus imports (can be positive
+ or negative -)
General rules: IN or OUT
GDP includes only FINAL G &S
GDP includes only products produced within a nation
GDP includes only what is produced during that year not what is sold.
GDP does not include 2nd hand goods
GDP does not include purely financial transactions
(ex: public transfer payments, Social Security or welfare benefits)
(ex: private transfer payments, student allowances, alimony payments)
(ex: sale of stocks and bonds represent a transfer of existing assets) but broker’s
fee is included for services rendered!