Documente Academic
Documente Profesional
Documente Cultură
Combined Version
Edwin G. Dolan
Best Value Textbooks
4th edition
Chapter 18
The Circular Flow of
Income and
Expenditure
The Basic Circular Flow of Income and
This figure shows the Expenditure
circular flow of
income and
expenditure for the
simplest possible
economy.
Production, carried
out by firms,
generates incomes for
households in the
form of wages,
interest, rents, and
profits.
Households
immediately spend all
of their income on
consumption.
Measures of Production: GDP
Gross Domestic Product (GDP) is the market value of
final goods and services produced within a country
during a specific time period, usually a year.
Valued at Market Value
Only Final Goods and Services Count:
Sales at intermediate stages of production are not counted
as their value is embodied within the final-user good. Their
inclusion would result in double counting.
Excludes financial transactions and income transfers since
these do not reflect production.
Must be produced within the geographic boundaries of the
country.
Net additions to inventory are current period output so are
also included.
Measuring Output as Income: GDI
Gross Domestic Income: GDI is the sum of the income
(including profits) received in producing final goods and services
during the period.
All of the payments made to producers are paid out to wage-
earners, business owners, governments, etc. Thus in total the
incomes must equal to the payments, which are equal in dollar
value to the total expenditures.
Payments include:
Wages and benefits paid to workers,
Proprietors income,
rents,
interest,
corporate profits,
Indirect business taxes
Net factor income from abroad
Capital consumption allowance.
4
Definitions:
Consumption: Purchases by
households for their own use.
1 1
Multiplier
leakages MPS MPI
MPS: marginal propensity to save
MPI: marginal propensity to import
Marginal Propensities
Marginal Propensity to Consume (MPC)
Marginal Propensity to Save (MPS)
Marginal Propensity to Import (MPI)
Each of these is stated in a decimal as a share of 1.
(They are considered as a percentage of disposable income
generally assigned to each of category of income
disposition)
For Example: MPS =0.2 means that 20% of disposable
income is saved in this economy.
Computing
the Spending Multiplier
1 1
Multiplier
leakages MPS MPI
If MPS = 0.30 and MPI is 0.10, then
MPS + MPI = 0.40 = 4/10.
GDP gap
Recessiona ry gap
spending multiplier