Circular Flow of the Economy: Scope and Diagrams

Study Notes

Macroeconomics

Macroeconomics studies the overall performance and behavior of an entire economy.
It focuses on aggregate variables such as national income, employment, inflation, and economic growth.
It examines the interactions between households, businesses, government, and international trade.

Circular Flow Diagrams

The circular flow model illustrates how money, goods, and services move between different sectors in an economy.
Households provide factors of production (labor, land, and capital) to firms through the markets for factors of production.
Firms use these factors to produce goods and services, which are sold in the markets for goods and services.
Households purchase goods and services from firms through the same market for goods and services.
Firms pay wages, rent, and profit to households for their supply of factors of production.
Households use this income to spend on goods and services supplied by firms.

National Income

Gross Domestic Product (GDP): The market value of all final goods and services produced within a country's borders during a specific period.
Gross National Product (GNP): The total income earned by a country's residents (including those abroad) from all economic activities.
Methods of calculating GDP:
- Expenditures Approach: Adds up spending on final goods and services (consumption, investment, government spending, exports, and imports).
- Income Approach: Adds up all income earned within the country (wages, rents, interest, profits).
- Value-Added Approach: Sums up value added at various production stages.
Nominal GDP: Measures GDP using current prices.
Real GDP: Adjusts nominal GDP for inflation, providing a more accurate picture of economic growth.

Inflation

Inflation: The sustained increase in the general price level of goods and services over time.
It erodes purchasing power and affects the cost of living.
Causes:
- Demand-pull inflation (excessive demand).
- Cost-push inflation (rising production costs).
- Built-in inflation (expectations of future price increases).
Effects:
- Redistributes income and wealth.
- Impacts savings, investments, and financial planning.

Description

Learn about the scope of macroeconomics and circular flow diagrams in the economy. Explore how macroeconomics studies the overall performance of an entire economy and illustrates the flow of money, goods, and services between different sectors.