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The open economy circular flow model
The markets
National account aggregates and conversions
The multiplier:
– Definition of multiplier effect
– explanation of the multiplier process aided with a
– circular flow and examples
Households: owners of the factors of production.
• Households offer FOP to firms
• Firms use FOP to produce goods and services
• Households receive income(rent, wages and salaries,
interest and profit.) from firms in exchange for FOP.
• Households use this income to buys goods and services
in the goods market.
Firms: use factors of production to produce
good & services
Firms buy FOP’s from households in exchange
for income (rent, wages and salaries, interest &
profit).
Government: national, provincial and local
Gov. supplies goods/services to households and
also taxes households and firms.
Foreign sector: countries in the rest of the
world.
Important for imports and exports
Factor market
(land, labour, capital, ent.)
(salaries and wages, interest,
rent, profits)
Goods market
Firms sell goods/services to households, other firms and the
foreign sector.
Financial market
Money and capital markets.
Surplus funds deposited & loans are made in the financial market.
Real flows – flows of physical Money flows – aka nominal
things.
flows consist of the flow of
money.
Leakages: factors that cause a decline in the flow of spending, income and
production.
Savings (S), taxes (T) & imports (M).
Decreases the flow of money and the total spending in the economy.
Injections: factors that cause an increase in the flow of spending, income and
production.
Investment (I), government spending (G) & exports (X).
SPENDING
FLOW
INCOME
FLOW
Spending on goods
PRODUCTION
and services
FLOW
(TS) = what is
Total
being
spending
produced
undertaken
(TP) =interest
whatby
isand
households
paidprofits
out
asto
Rent,
wages/salaries,
Consists
of consumer
goods/services
and
capital
(consumption)
and
firmsin(investment).
income
(TI) to
FOP
used
production.
households
from
firms.
goods.
TS = C + I
S isspending
a leakage
C =TS
800
=inTP
IYthe
is==an
1model
TI000
injection
The total
is equal to:
S ==Equilibrium
YC–+CI =Y1800
=000
1 000
–200
800
S= =1 I200
TS
+since
000
From this three-sector circular flow
we can see that…
• Demand for goods/services in our economy
consists of C + I + G
• Flows of spending, production and income are
equal.
• 2 leakages: savings (S) and taxation (T).
• 2 injections: investment spending (I) and
government spending (G).
• In equilibrium leakages = injections (S + T = I +
G)
TS =injections
TP = TI
Total
Total
leakages
TS =Yd
IIYS++–
G
=
900
+
200
+
100
=
1
200
Equilibrium
SC=+=Yd
T
C
=
1
since
200
150
–
S
50
+
900
T
=
=
=
1
I
250
150
+
G
Y250
= 1200
+GT==200
++100
50 ==300
300
From this four-sector circular flow we
can see that…
• Demand for goods/services in our economy
consists of C + I + G + (X – M)
• Flows of spending, production and income are
equal.
• 3 leakages: savings (S) and taxation (T) and
imports (M).
• 3 injections: investment spending (I) and
government spending (G) and exports (X).
• In equilibrium leakages = injections
(S + T + M = I + G + X)
TS
= CTS
(X
M)
Injections
=S–I=+++CTTI
X
Leakages
S+Yd=I =+Yd
TP
=YG
TG+–+M
==200
++Y100
100
=400
400
==+230
11200
130
080
=––100
150
850
++130
120=
1 230
080
= 850
+50
+= =(100
– 120)
= 1 130