The Circular Flow &
GDP
AP Macroeconomics
Gains from Exchange
http://yadayadayadaecon.com/clip/33/
National Income & Product Accounts
(aka National Accounts)
What are they? A set of numbers that every
country calculates
In the US, the Bureau of Economic Analysis
calculates these numbers
They keep track of consumer spending, sales of
producers, business investment spending,
government purchases, among other things
Remember that diagram?
 What does it represent? That the flow of money into
each market or sector is equal to the flow of money
coming out of that market or sector.
 It helps us to understand the underlying principles of
national accounts.
 It shows the flows of money, goods and services, and
factors of production through the economy.
The “Simple” Circular Flow
Diagram
2 “inhabitants” in a simple
economy
Households: either an
individual or a group of
people who share their
income
Firms:
organizations that
produce goods or
services for sale—
and that employs
members of
households
2 “markets” in a simple economy
Product Market: in which
households buy goods
and services they want
from firms.
Factor Markets: in
which firms buy
resources they need to
produce goods &
services (i.e. labor from
households)
The “Expanded” Circular Flow
Diagram
 It is “expanded” to include extra elements ignored in
the simple diagram in order to keep it “simple” or easy
to understand
 The underlying principle (that the in-flow of money
into each market or sector must equal the outflow of
money coming from that market or sector still applies)
EXPANDED CIRCULAR FLOW
DIAGRAM
In product markets…
 People engage in consumer
spending, or buying goods &
services from domestic firms
and from firms all over the
world
In Factor Markets…
 Households also own factors
of production – land, labor,
and capital.
 They sell these factors to
firms in return for rent,
wages, and interest payments.
A little deeper…
 For the most part, households spend most of their income
received from factors of production on goods and services
 However, not all of it is spent on goods & services – some of it
must necessarily go to the government in the form of taxes
(income, and sales) What is the NC sales tax?
 Another portion of that money is set aside in the form of savings (in
financial markets and private savings)
 And the government makes payments to some households
without expecting payment in return. Can we think of an
example?
What’s left?
 Wow. So after paying taxes
and receiving government
transfers (i.e. payments from
the government), we can all
whatever it is that is leftover
“disposable income”
The government giveth and taketh
away
 While the government takes from households in the
form of taxes, it also gives it back (as previously
mentioned) in the form of government transfers
 The government also partakes in purchases of goods
and services (think military, A.C. Reynolds HS, and
that sidewalk that you [would never] spit on outside
your house)
The rest of the world in eins, zwei,
und drei…
 The rest of the world also participates in the US
economy, and it does so in three ways:
 1) Exports – flow of funds into the US
 2) Imports – flow of funds out of the US
 3) Participation in US financial markets by
foreigners
GROSS DOMESTIC PRODUCT
…aka GDP…
What is GDP?
GDP is the total value of all final goods and services
produced in an economy during a given period, usually
one year.
Calculating GDP in eins, zwei, und
drei
There are three ways to calculate GDP:
1) Survey firms and add up the total value of their
production of final goods and services (add up the
value of all goods & services produced in the
economy, excluding intermediate goods & services)
Method zwei
2) Add up aggregate spending
on domestically produced
final goods & services in
the economy (GDP
measured by flow of funds
into firms. This method
avoids double-counting,
that is we wouldn’t count
both the consumer’s
spending on a burger and
the butcher’s spending on
the cow)
GDP = C+I+G+X-IM
C= Consumer spending
I= Investment spending
G= government purchases
of goods & services
X=sales to foreigners
(exports)
IM=spending on imports
X-IM = (difference between
the value of exports and
the value of imports in aka
net exports
Method drei (not as emphasized
as the first two)
3) Sum the total factor income earned by households
from firms in the economy (add up all the income
earned by factors of production [Note: the wages
earned by labor; the interest earned by those who
lend their savings to firms & the government; the
rent earned by those who lease their land or
structures to firms; and the profit earned by
shareholders}
What’s Included in GDP?
• Domestically produced final goods & services
•This includes the following:
•Capital goods
•New construction of structures
•Changes to inventories (stocks of goods
and raw materials that firms hold to
facilitate their operations)
What’s excluded in GDP?
 Intermediate goods & services
 Inputs
 Used goods
 Financial assets such as stocks [i.e. shares in
ownership of a company] and bonds [i.e. loans
to firms in the form of an IOU that pays
interest]
 Foreign-produced goods & services
And Now…
Homework: Morton WB, Activity 12
www.reffonomics.com > Macroeconomics
Works Cited
The Economics of Seinfeld. “Gains from Exchange.”
http://yadayadayadaecon.com/clip/33/
Krugman, Paul, and Robin Wells. Krugman’s Economics
for AP. New York, Worth Publishers.
Reffonomics. www.reffonomics.com.