Circular Flow and GDP

1. Circular Flow and GDP 2 Methods and 4 Categories of GDP

2. Basic Principles of Circular Flow • Circular flow model is MACRO picture of economy • National accounts indicate levels of economic development (flow of money) • One principle that applies to BOTH – Flow of money into each sector is equal to flow of money out of that sector This also applies to the EXPANDED circular flow model.

3. Elements of Expanded Model

4. Gross Domestic Product – Final Goods & Services • Only includes final goods & services (direct to consumer), not intermediate (producer-to-producer sales) • This is to avoid counting values two or more times

5. Gross Domestic Product – Two Methods • Value of production – To avoid duplication, each step in production only counts for “value added” – difference between sales & value of inputs purchased • Value of spending – Again, only counts final purchases (by consumers). Capital goods that last for years count in GDP.

7. Gross Domestic Product – Four Categories • GDP = C + I + G + X – IM • Imports are “leakage” as this is money that exits circular flow

8. Gross Domestic Product: What’s Included/Excluded? Included • Investment spending by businesses • Domestically produced final goods & services A note about inventory – Once released for sale, it is subtracted from GDP. Excluded • Intermediate goods & inputs that are used up in production • Used goods • Stocks & bonds • Imports • Government transfers • Nonmarket transactions