AP Economics

Presentation
Circular Flow
By Chart
Triwit Ariyathugun

Teacher
Mr. J. Roderick Eaton

02/25/2009
 The Circular Flow
Diagram
• The way to see the economic
interactions among main sectors in the
economy is through a circular flow
diagram.
• The circular flow diagram shows three
links between the domestic economy
and the rest of the world. Three links
are
- Imports
- Exports
- A flow of funds borrowed from
foreign lenders
Regarding this circular flow, there are
seven sectors of the economy in the
• Household
• Firms
• Product Markets
• Factor Markets
• Financial Markets
• Government
• Foreign Economies
 Circular Flow Foreign
DiagramExports Economie
s
Product
National Consumption
Markets

Imports
product expenditure
Investment Governmen
Expenditure t Purchase
Governmen
t Net
Taxes
Household
Firms
s
Investment Saving
Government

cit
Funds
Borrowing

fi
de
tra o
fin eign rom

de
ce s t
Financia

an er
for ans f
l
Markets
Lo

Factor Factor National Income

payments Markets
 Household
• Receive
- “national income” from their work
- transfer payments: social security
benefits, veteran benefits, and welfare
payments
• Consume
-“C” : Consumption Expenditure (part
of GDP)
- Pay taxes to government
- Save by putting money in financial
markets
 Firms
• Receive
- national product from product
markets
- investment funds from financial
markets
• Pay
- factor payments to factor markets
Foreign Economies
• Receive
- Money from imports
• Pay
- Exports to product markets
- Loans to finance trade deficit
 Product Markets
• Receive
- money from Consumption
Expenditure
- money from Government
Purchases
- money from Investment
Expenditure
- Exports to foreign economies
• Pay
 Factor Markets
• Receive
- Factor payments from firms
• Pay
- National income to households

Government
• Receive
- Money from net taxes paid by
households
- Borrow money from financial markets
• Pay
- Pay Government Purchase to buy
 Financial Markets
• Receive
- Savings from household
- Loans from foreigners to finance
trade deficit from foreign economies
• Pay
- Pay government due to
“government borrowing”
- Pay requested “Investment funds”
to firms
 GDP (Gross Domestic
Product)
• J.R.E.’s Definition: The Dollar Value
of the total amount of final goods +
services produced in a country
annually.
• GDP (F!) = C+I+G+ (Ex-Im)
• C = Personal Consumption
Expenditure
• I = Gross Private Domestic
Investment
• G = Government Consumption and
Gross Investment
GDP = C+I+G+ Foreign
(Ex-Im) Exports Economie
s
Product
National Consumption
Markets

Imports
product expenditure
Investment Governmen
Expenditure t Purchase
Governmen
t Net
Taxes
Household
Firms
s
Investment Saving
Government

cit
Funds
Borrowing

fi
de
tra o
fin eign rom

de
ce s t
Financia

an er
for ans f
l
Markets
Lo

Factor Factor National Income

payments Markets
 Fun Facts…
• Consumption Expenditure (C) is the
largest and most stable component
of GDP. It adds up approximately two-
thirds of GDP.

• Investment Expenditure (I) is

considered the most volatile factor of
GDP.
 Leakages and Injections
• The leakage-injection approach to
equilibrium output focuses on saving
and gross exports as spending
injections. Leakages depress
aggregate spending, while injections
increase aggregate spending.
• Leakages = Savings + Taxes +
Import
• Injection = Investment Expenditure
- Leakages = S + Foreign
T+M Exports Economie
s
- Injections = I +
Product
National Consumption
Markets

Imports
product expenditure
Investment Governmen
Expenditure t Purchase
Governmen
t Net
Taxes
Household
Firms
s
Investment Saving
Government

cit
Funds
Borrowing

fi
de
tra o
fin eign rom

de
ce s t
Financia

an er
for ans f
l
Markets
Lo

Factor Factor National Income

payments Markets
The point where the leakage and the
injection graphs cross represents the
“Equilibrium GDP (Ye).”
The End
250 + 25
= 275