1 In macroeconomics, we study the economy of one country.
2 Then try to understand how 2 countries interact and trade.
3 And hopefully, understand the global economy.
4 So today, we are going to study the circular flow of income.
5 Let’s make things really simple.
5 Imagine we are alone on an isolated island. There’s no government, no trade, no savings.
I told you, it's simple!
6 There’s only firms and households. (2-sector economy: firms + households (closed economy))
7 Firms provide households with goods and services.
7 Out of thin air?
8 Firms gotta get factors of production from households.
8 It can be labor, land, capital or…
8 Face it. Some of us in households are going to be entrepreneurs. (For more information on factors of production: check out this video)
9 For free? You wish!
9 We don’t get freebies from firms.
9 We don’t provide labor for free either.
10 So there’s money flowing in the opposite direction.
11 Households gotta pay firms for the goods they get.
12 Firms also gotta pay households in the form of wages, rents, interests or profits.
12 But this is a little weird.
12 We don’t spend everything we earn in real life.
13 So let’s add savings.
13 Savings is money we don’t spend.
13 So there’s money flowing out.
14 Hey, savings don’t just sit in banks…
14 Banks invest in firms by lending to them.
14 Cos firms need money to buy capital equipment or cover other costs of production.
14 So there's investments flowing into the economy.
14 Bravo! Awesome!
14 But this is a little too simplified.
15 Let’s add government. (3 sector economy: firms + households + government)
15 Government buys stuff as well.
15 So there’s money flowing in.
16 Government gets money from taxes.
16 Taxes. So there’s money flowing out.
16 Cos for the money we’re paying as taxes, we cannoyt spend it.
17 Lastly, countries interact with one another.
17 Imagine this is an American economy.
18 Let’s add trade. (4 sector economy: firms + households + government + foreign sector)
18 America imports stuff.
18 For example, America can import shoes from China.
18 Shoes flow from China into America.
19 And money spent on imports flows out of America into China.
19 America exports too.
19 America can produce software
19 and export it to foreigners,
20 Money then flows from foreign countries into America.
20 This is America's export earnings.
21 Investments, Government Spending and Export earnings are called Injections.
21 Cos money is flowing in.
22 Savings, taxes and import spending are called leakages or withdrawals.
22 Cos money leaks out of the system.
And hey, injections and leakages are sort of related.
Investments come from savings.
Government spending comes from taxes.
America makes money from foreigners by exporting.
But foreigners also make money from America when America imports.
Wow…no wonder it's Circular Flow of Income
It tells us roughly how an economy functions.
23 How do we measure the size of an economy then?
24 By measuring Gross Domestic Product or GDP.
24 GDP is the total value of all final goods and services produced within the borders of a country during a given period.
25 Why must it be FINAL goods and services?
(Hint: it's in the next video)
26 If you like this video, remember to like and subscribe.
27 Next up: Measuring GDP: Output Approach
How does an economy function? Look at the Circular Flow of Income.
Who are the major players in an economy? In order of increasing complexity, there are:
2-sector economy: households + firms
3-sector economy: households + firms + government
4-sector economy: households + firms + government + foreign sector
There are real goods and services flowing in one direction in the circular flow of income and money flowing in the opposite direction. When money flowing to the country, it's called injections. When money flows out, it's called withdrawals or leakages.
Injections consist of government spending, investments and exports. Leakages or withdrawals include imports, taxes and savings. Injections and leakages/withdrawals are related to each other. This is because government spending comes from tax revenues and investments, at least the local component, come from savings. That said, investments can flow from foreign countries in the form of foreign direct investments (FDI). Lastly, while money can flow from foreign countries when we export overseas, money also leaks out of the country because we import.
Gross Domestic Product or GDP is the total value of all final goods and services produced within the borders of a country during a given period.
Use flashcards to remember these definitions in economics: