CHAPTER 1: The circular fow of the economyThe model represents all of the actors in an economy either households or frms (companies), and it divide markets into two categories: markets for goods and services markets for factors of productionConcepts to be considered Circular fow model show how the economic participants interact with one another Maret is a place where the potential buyers and potential sellers meet !pen economy is the economy that imports and exports goods and service to other countries Closed economy is the economy that has no foreign sector/ no international trade "actor maret# the market in which factors of production are traded $oods marets# the market in which goods and service are traded1%1 Circular fow of an open economy1%1%1 Participants of an open economy1% Household &consumers of economic goods and service) ousehold own factors of production !ell factors of production to the frms in factor market household consume goods and service from frms in goods market symbol " is use to indicate consumption spending by household'% "irms (businesses or producers) #urchase factors of production from household in the factor market They then use factors of production to produce goods and service $oods and services are sold to household in the goods market1% $o(ernment&state or public sector) #urchase factors of production from households in the factor market #urchasegoods and services from frms in goods market( symbol $ denote government spending) !tate provide goods and services that are not produced by frms, which are known by public goods $overnment receive revenue from household and frms in the form of taxes(symbol T denote taxes) %lso receive revenue from state&owned property and state&owned enterprises'( "orei)n sector( other countries of the world) Trade between foreign sector and household and frms take placein the form of imports and exports )mports are goods and services that are produced in other countries and purchased by local frms and household(symbol * donate imports) +xports are goods and services that are produced locally and then sold to other countries(symbol , donate exports)*% "inancial sector(fnancial institution) The money which household and frms provide to the fnancial sector is known as savings( symbol ! denote savings) The funds collected by the fnancial sector are used to provide frms with the money they need to purchase capital e-uipment !pending on capital e-uipment by frms is known by investment(symbol ) denote investment).(.('"ircular /ow diagram of the economy1%1%+ Real and money fow ouseholds earn income from selling their factors of production to frms( ousehold buy goods and services from frms and therefore a /ow of goods and services from frms to households( 0low of money in the form of taxes from households and frms to government 0low of goods and service whereby public goods and services are consumed by households and frms( !aving and investment show the /ow of money between fnancial sector and household and frms(1%1%, -eaa)es and in.ections.( 1eakages 2epresent the withdrawal of money from the local economy money thatdoes not give rise to a income in open economy leakage are: Taxes (T): +xpenditure on imports (*): !avings(!)'( )n3ection represent introduction of additional money into the economy any spending which is not derived from income in open economy in3ection are: $overnment spending ($): The revenue earned from exports: )nvestment spending1%1%* The basic e/uation of this model%ggregate spending (total spending) and aggregate income (total income)%ggregate spending is made up on of the following concepts: "onsumption spending (") )nvestment spending by frms ()) $overnment spending ($) !pending by foreigners on !% goods (exports: ,) minus spending by!% on foreign goods (imports:*) )n other words aggregate spending 4"5)5$5,&*!ince aggregate spending is e-ual to aggregate income formula is thesame %ggregate income 6 4 "5)5$5,&*Autonomous consumption&c#0 and mar)inal propensity to consume &c0.( %utonomous consumption(c & )4 the amount of money households spend regardless of income propensity (tendency)'( 7arginal propensity1%' 1ational account a))re)ates 7easures of economic activities)( To determine the standard of living))( To compare prosperity levels between countries)))( To measure economic growth from one year to the next The used of national aggregate is the value of all goods and services produce within the country in a given year (known as gross domestic product $8#) $8# fgures are recorded in the national accounts which are published by !%291%'%1 Calculatin) domestic productionThree ways of calculatin) $2P 1% production method"alculating the sum of the value added at each stage of production process (yield $8# at basic price)('% income method"alculating the income earned by the factors of production within the borders of the country (yield $8# at basic price)(+% E3penditure method"alculating the total expenditure on all goods and services produced within the borders of the country ()5)5$5,&*)( (6ield $8# at basic price)(1%'%' 1ational account con(ersion%( 8istinction between tax on products and other taxes on production Ta3 on production& refer to any tax that is levied per unit of the good or service and includes value added tax (:%T), import duties,other tax on imports and tax on exports !ther ta3es on production&refer to taxes on production that arenot linked to specifc good and service but include payroll taxes, business licenses and tax on land(4% E/uation of con(ersion from $2P at factor cost to $2P at 4asic price or $2P at maret prices $8# at market prices4 $8# at basic prices 5 tax on products ; subsidies on products $8# at factor cost 4 $8# at basic prices ; other taxes on production 5 other subsidies on production1%'%+ 2omestic production (ersus national production $ross domestic product ($8#) refer to the value of all fnal goodsand services that produced within the borders of a country during a given year $ross national product refer to the value of all fnal goods and services produced by the permanent residents of the country during a given year( $8# is converted to the $