I. Circular Flow Diagram
A. Resource Market and Factor Market
1. Households own factors of production – sell them to Firms
2. Firms buy factors of production – pay wages, rent etc.
B. Product Market
1. Firms sell goods and services to households
2. Households pay for goods and services
Circular Flow
Write the following in the
circular flow diagram:
Households
Entrepreneurship
Firms
Product Market
Factor Market
Land, labor, and Capital
Money – wages etc.
Goods and services
Money – revenue etc.
Factor
market
Firms
Households
Product
Market
• buy the factors of production
• Buyers in the resource
market
• Sell goods and services
• Sellers in the product market
• Pay wages for factors of
production
• Owners of the factors of
production
• Buyers in the product market
• Pay revenue in exchange for goods
and services
• Sellers in the resource market
• Receive wages in the resource
market
Product Market
Resource Market
Product Market
•
•
•
•
households are buyers
Firms are sellers
Households buy consumer goods
Firms receive money or revenue
Resource Market
• Firms are buyers
• Households supply land, labor,
capital and entrepreneurship
• Households are sellers
• Households receive money
What doesn’t count
1. Second hand goods
2. Gifts or transfers (social security welfare etc.)
3. Stock market transactions
4. Unreported business activities
5. Illegal activities
6. Financial transactions between banks and businesses
7. Non market activities like volunteer work
Formula
The expenditures approach - CC++IgIg++GG++Xn
Xn==GDP
GDP
1. C = Personal Consumption
a. a. 67% of the economy
b. Purchases of finished goods and services
c. NOT houses or other construction
2. Ig = Gross Private Business Investment
a. Factory equipment maintenance
b. New factory equipment
c. New Construction (houses or factory)
d. Unsold inventory of products build in a year, but not
sold in that year
3. G = Government Spending
4. Xn = Net foreign factor of Trade: Exports minus Imports
a. Exports = dollars in
b. Imports = dollars out
c. Since WWII, Xn has usually been a negative number
Fill in the Formula on your
handout!
Net Exports
X-M
Investment
Consumption
Government Spending
GDP = C + Ig + G + Xn
GDP = C + Ig + G + Xn
Net Exports
X-M
Government Spending
Investment
Consumption
Consumption
Doesn’t Count in GDP
Investment
Government
Spending
Net exports
GDP = C + Ig + G + Xn
•
•
•
Consumer spending
College textbook
Home computer
Net Exports
X-M
Government Spending
Investment
Consumption
Consumption
Government
Spending
•
•
Military spending
An FBI agent’s
paycheck
Doesn’t Count in GDP
•
•
•
•
•
•
Consumer savings
Transfer payments
Stocks and bonds
Used goods
Clean air
Intermediate good
Investment
•
•
•
•
•
New House
Machine in a
factory
Capital goods
Additions to
business inventory
New shopping
mall built
downtown
Net exports
•
•
•
•
Ford F150 truck
made in San
Antonio but sold in
Germany
Exports – imports
Marlboro cigarettes
made in South
Carolina and sold to
French Smokers
Mercedes made in
Germany but sold in
San Antonio (-M)
Nominal GDP vs. Real GDP
1. Nominal GDP
a. Total output of final goods and services produced
by an economy in 1 year
b. no adjustment for inflation
2. Price index
a. Used to measure price changes in an economy
b. To construct select a year to serve as the base year
c. Prices of other years are expressed as a percentage
of the base year
d. The value of the price index in the base year is
always 100
3. Real GDP
a. Adjusted for price changes over time
b. Requires a price index
4. GDP Deflator
a. Price index used to “deflate” nominal GDP to reflect
real growth
Real GDP
VS.
Nominal GDP
Determine if the BLUE card is a
characteristic of Nominal or Real
GDP and sort them accordingly.
Real GDP
VS.
• Adjusted for inflation
• Calculated by using a price
index
• Shows how prices have
changed over time
• Measures changes in
production not price increases
• May or may not increase when
prices go up
Nominal GDP
• Shows the value of current
products at current prices
• Increases when price goes up
• Calculated by adding the value
of all items produced in an
economy for a particular year
Use the information below to calculate Nominal
GDP in Narvaizland
Billions of dollars
Exports
Dividends
Consumption of fixed capital
Corporate profits
Personal consumption
Compensation of employees
Government purchases
Rents
Taxes on production and imports
Gross private domestic investment
Imports
$367
60
307
203
1810
1722
577
33
255
437
338
Narvaizland GDP
Consumer Spending
Gross Investment
Government Spending
Net Exports
1810
437
577
29
GDP
2853
To find Net exports
Exports – Imports
367 - 338 = 29
IV. Unemployment
Unemployed
A. Unemployment rate =
x 100
Labor force
B. Who isn’t in the labor force
1. under 16
2. in the military
3. institutionalized
4. retired
5. homemakers
6. students
7. discouraged Workers
Sort the RED cards based on what the action
would do to the rate of unemployment.
Increase in
unemployment rate
Decrease in unemployment
rate
No change in
unemployment
Increase in
unemployment rate
• Factory closes and
outsources all jobs
to China
• In May college
students graduate
and start look for
jobs
• John quit his job
goes back to
school to work on
a master’s degree
Decrease in
No change in
unemployment rate unemployment rate
• New restaurant
• Rosie takes a year
opens and hires
off after
staff
graduation to
• George has been
travel before
out of work for
looking for a job
so long he stops
looking for a job
Use the information below to
calculate the size of the labor
force in Narvaizland.
Full time workers
Part time workers
Retired workers
People looking for work
Teens working after school
Stay at home moms
2,000
500
350
100
200
50
Labor
Force
2,000
500
+100
2,600
Business Cycle – alternating rises and declines in economic activity
A. Peak – business activity has reached a temporary maximum
B. Recession – decline in total output, income, employment, and
trade
C. Trough – output and employment are at their lowest levels
D. Recovery – output and employment rise toward full
employment
Other business cycle measures
1. Stagflation – when inflation and unemployment rise
simultaneously
2. Misery Index – a measurement that combines
unemployment and inflation
Decide if unemployment and inflation will increase or
decrease or not change during phases of the business
cycle listed.
unemployment
Recession
Stagflation
Recovery
peak
trough
inflation
Decide if unemployment and inflation will increase or
decrease or not change during phases of the business
cycle listed.
Recession
Stagflation
Recovery
peak
trough
unemployment
inflation
increase
increase
decrease
No change
No change
decrease
increase
increase
No change
No change