Module 13 Circular
Flow of Income
Production possibilities Frontier (PPF)
Describes the best possible
combination of two goods to produce using all of the available resources
Shows trade-off between more of
one good in terms of the other
Table-1.
Alternative Production Possibilities
|
Possibilities |
Bread (in units of 1,000 Kgs) |
Guns (in units of 1,000 pcs.) |
|
A |
0 |
15 |
|
B |
1 |
14 |
|
C |
2 |
12 |
|
D |
3 |
9 |
|
E |
4 |
5 |
|
F |
5 |
0 |
As we
go from A to F, we are transferring resources from the gun industry to the bread
industry.
From the data in Table-1, we can prepare the graph as shown above., and draw the curve showing the PPF.
Efficiency
Operating on the
frontier implies that the economy is efficient. Any point outside the frontier
is in Impossible region and hence not viable. This frontier shows the schedule
of choices along which society can choose to substitute guns for bread. Points
outside the frontier,( say I ) , are infeasible or unattainable. Any point
inside the curve, ( say U ) indicates that some resources are unemployed or not
used in the best possible way. Productive Efficiency occurs when society cannot
increase the output of one good without cutting back on another good.. An
efficient economy is on its PPF
Circular Flow of Income –2 sector model
Income - Individuals--people living in households--work for businesses, rent
their property (or their capital) to businesses, and manage and own the
businesses.
Expenditure - flows of payments from businesses to households.
But households then spend their incomes--on consumption goods, in taxes paid to
governments (that then spend the money on goods and services), and on assets
like stock certificates and bank CDs that flow through the financial sector and
are then used to buy investment and other goods.
Theory of Income Determination
|
Return
to factors of production |
= |
Value
of final goods & services produced (GNP) |
|
|
|
Nation
Income |
= |
National
Output |
|
|
|
Total
output |
- |
Value
of goods & services consumed |
= |
Resources
available for Investment |
Flow of Money
Gross National
Product (GNP) The output method: the
total amount of goods and service produced in one year
GNE The expenditure
method: the total amount of domestic spending by
consumers, firms, government and foreigners
Gross National
Income (GNI or Y) The income method: the
total incomes earned by the factors of production involved in the production of
goods and services in one year
National Output
Closed economy
‘ – Economy with no international
trade
Demand
for National output by 3 groups
1)
Household
2)
Business
3)
Government
|
Gross
Domestic Expenditure (GDE) |
= |
Value
of final goods & services produced Gross National Product (GNP) |
|
Flow
of resources required to produce GNP |
+ |
Returns
earned by resource owners |
|
Gross
National Product (GNP) |
= |
Rewards
to resource owners |
|
Gross
Nation Income (GNI or Y) |
= |
Gross
National Product (GNP) |
|
Aggregate
Demand |
= |
Consumer
Demand |
+ |
Firm
(Business) Demand |
+ |
Government
Demand |
|
|
|
|
|
|
|
|
|
Gross
Domestic Expenditure (GDE) |
= |
Consumption
Expenditure (C) |
+ |
Investment
Expenditure (I) |
+ |
Government
Expenditure (G) |
|
|
|
|
|
|
|
|
National Income and Expenditure
Equality
|
Expenditure
|
= |
Value
of Output |
= |
Income |
|
|
|
|
|
|
|
GDE |
= |
GNP |
= |
Y |
= |
C |
+ |
I |
+ |
G |
Measured 3 ways
1)
a sum of expenditures
2)
a sum of output (value added)
3)
sum of factor income
in theory yield the same estimate of national
income in practice they seldom do,to ensure equality item known as ‘statistical
discrepancy’ or ‘residual error’ is used
Open Economy
-– Economy with international trade
Foreigners buy goods and services
or exports (X)
Domestic Households, Business,
Government by foreign produced goods and services (Z)
When domestic expenditure >
Output Imports(Z) > Output(X)
When domestic expenditure <
Output Imports (Z) < Output (X)
|
GNP |
= |
Y |
= |
C |
+ |
I |
+ |
G |
+ |
X |
- |
Z |
|
GDE |
= |
C |
+ |
I |
+ |
G |
|
|
|
|
|
|
|
GNP
– GDE |
= |
X |
- |
Z |
|
|
|
|
|
|
|
|
National Income
Everything that is
produced, earned or spent in a country Gross Domestic Expenditure (GDP) / Gross
National Production (GNP)
|
Y |
= |
C |
+ |
I |
+ |
G |
+ |
X |
- |
Z |
Investment
Can be:
(+) positive
(0) zero
(-) negative
Depends on Interest Rate (R), Gross National Income (GNI or Y) , Replacement Expenditure (depreciation or capital consumption), expectations and adjustment to inventory in the current year.
Gross Investment
|
Gross
Investment |
= |
Total
expenditure on investment |
Net Investment
|
Net
Investment |
= |
Gross
Investment |
- |
Replacement
Investment |
Can be:
(+) positive
(1) zero
(-) negative
Depends on gross investment exceeds is equal or less than replacement investment
|
Replacement
|
< |
Gross
investment |
Then |
Net Investment |
Increase |
|
|
|
Production
|
> |
Consumption |
Then |
Inventory
add to stock |
Results
in |
Net
Investment |
Increase* |
*this can cause actual investment expenditure to be higher than planned investment