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The Expanded Circular Flow
Adding New Players, Interactions & Flows
The Core Circular Flow Model
Revenue
Goods
and services
sold
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
•Households buy
Spending
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Wages, rent,
and profit
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs and outputs
= Flow of dollars
New Players:
• Financial Institutions
• Government
• “The Rest of the World”
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Savings = Not Spending
• Imagine Savings of 10% of Income
• Creates a “Leak” Out of the System • Economy Spirals Downward
$10
$9
House
Holds
$81$90
Firms
$100
$81
$90
A New Player:
• Financial Institutions
– Banks
– Credit Unions
– Mutual Funds
Mutual Funds
– Stock/Bond Markets
Financial Institutions
• Link Borrowers & Lenders
• Put Money Back Into System
• Offset the “Leak” with an “Injection” Financial
IInstitutions
i i
$10
$90
House
Holds
Firms
$100
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Yet Another Player
• Government
– Federal
– State & Local
– Special Districts
Special Districts
Governments’ Role
• Set Ground Rules (Laws/Courts)
• Be A Buyer or Provider of Goods
– Private Goods
– Public Goods
• Fix "Market Failures"
– Lack of Competition
– "Externalities" or "3rd Party Effects"
• Redistribution of Income?
• Promote Economic Stability?
One Approach to the Role of Government
Expanding the Circular Flow
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Circular Flow Revisited: Gov. 1
• Government
– Taxes
– Another Leak
Financial
IInstitutions
i i
House
Holds
Firms
Gov
Circular Flow Revisited: Gov. 2
• Government
• Government
– Factor Payments
– Transfer Payments
– Spending
– Another Injection
Financial
IInstitutions
i i
House
Holds
Gov
Firms
Government’s Role
• Demander/Supplier of • Redistribution Agent
Goods & Services
• Economic Stabilizer
• Demander of Resources/Factors Financial
I i i
Institutions
House
Holds
Gov
Firms
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The International Sector
Rest of
World
Imports
Leakage
Exports
Injection
Financial
I i i
Institutions
House
Holds
Gov
Firms
The “Rest of the World”
• Grossly Oversimplified
• Imports/Exports
• Added Complexity
– New Goods/Services
N G d /S i
– New Players/Decisions
– New Money
– Gov. Policies
The Core of “Macro” Economics
• Learn What Important Flows are Tracked
• Understand the Various Flows
• Develop Models to Explain Flows
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The Core of “Macro” Economics
• Learn About the Interplay: – How Aggregate Economy is Supposed to Function
– What Can Go Wrong
– What Policy Options are Available to Fix
What Policy Options are Available to Fix
Wrap Up:
• New Players in Expanded Circular Flow
– Financial Institutions, Government, Rest of World
• New Flows
– Leakages & Injections
Leakages & Injections
• Broad Framework
– Tracking the Economy
– Understanding/Evaluating “Shocks” to System
– Understanding/Evaluating Public Policy
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