Measuring Economic Growth and the Circular Flow of Income

Introduction

• Objective: Understand how economic growth is measured.
• Premise: Need to know what the economy is to measure its growth.

Circular Flow of Income

• Purpose: Models the economy to measure growth.

Two Economic Agents: Households and Firms

• Households:
  • Provide labor and entrepreneurship to firms.
  • Receive income as rewards.
• Firms:
  • Produce goods and services.
  • Pay incomes to households.
• Process:
  • Income received by households is spent on goods and services from firms.
  • A basic two-sector model.

Expanding the Model

• Government:
  • Spends money and taxes people.
• Global Economy:
  • Trade with the rest of the world.
  • Imports (money leaves the country) and exports (money enters the country).
  • Other ways money enters/leaves the economy.

Four Sectors in the Expanded Model

1. Consumer Expenditure
2. Government Spending (G)
3. Investment (I): Spending by firms.
4. Exports (X): Money from foreign purchase of goods/services.

Injections

• Definition: Ways money is injected into the circular flow.
• Types:
  • Government spending (G)
  • Investment (I)
  • Export revenue (X)
• Impact: Lead to more money entering the economy.

Leakages

• Definition: Ways money leaves the circular flow.
• Types:
  • Savings (S)
  • Taxation (T)
  • Spending on Imports (M)
• Impact: Money leaves the economy or is not spent.

Understanding Economic Growth

• Growth Determinants:
  • Injections (G + I + X) > Leakages (S + T + M): Economic growth occurs.
  • Leakages > Injections: Fall in growth.
• Short-term Growth:
  • Determined by the balance of injections and leakages.
• Long-term Growth:
  • Increase in quantity and quality of factors of production.
  • Larger size of the circular flow.

Conclusion

• Review of basic circular flow, injections, and leakages.
• Importance: Understanding mechanisms for economic growth.

Next Session

• Detailed discussion on long-term growth.