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Principle of Economics1 (Chapter2)

The document discusses the circular flow of economic activities between households and firms. It explains that households provide factors of production like labor, land, and capital to firms, who use these resources to produce goods and services. Firms then provide income payments to households in exchange for the resources. Households then use this income to purchase goods and services from firms, completing the circular flow. The circular flow involves the continuous exchange of resources, outputs, and payments between producers and consumers in the economy.

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MA Valdez
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51 views7 pages

Principle of Economics1 (Chapter2)

The document discusses the circular flow of economic activities between households and firms. It explains that households provide factors of production like labor, land, and capital to firms, who use these resources to produce goods and services. Firms then provide income payments to households in exchange for the resources. Households then use this income to purchase goods and services from firms, completing the circular flow. The circular flow involves the continuous exchange of resources, outputs, and payments between producers and consumers in the economy.

Uploaded by

MA Valdez
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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PRINCIPLE OF ECONOMICS:Circular Flow of Economic Activities

THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

There are two basic activities undertaken in any economy; production and consumption.
The firms perform the production and consumption.To be able to produce firms need the economic
resources consisting of land,labor and capital

LAND- it is one of the factors of the production which include land used for agriculture or industrial
purposes as well as natural resources taken for above or below the soil .Natural resources consist of
energy resources like fossil fuel and geothermal emissions, non-energy resourceslike gold,diamond and
limestone,air and water and many others.
LABOR-refers to that basic factor of production which are productive services embodied in human
physical effort,skill,and intellectual powers,and others.It consist of human time spent in production like
driving buses,feeding castle,singing in night clubs,acting in movies, or repairing household appliances.
CAPITAL-Durable goods produced in order to produce other goods.It consist of buildings,plant and
machinery,roads,computers,ships,electric gitar,table tennis,tennis ball etc.

STOCK AND FLOW CONCEPTS


STOCK-Refers to the measure of quantity at a pointof time e.g.wealth as of December 31,2001
FLOW-Refers to the measure of movement of quantity of over a period of time e.g. savings(P1000/year)
or consumption at P100,000/year

When economic resources are used in the production of goods and services employment of these
resources occurs
.A price is paid to resources owners whenever these resources are used in production. Rent is paid to
the landowner, interest to the capitalist and wage to labor.The goods and services produced by these
firms are consumed by households.
The interaction between households and firms regarding production,consumption, employment
and income generation result to the circular flow of goods and services in the economy.

THE CIRCULAR FLOW OF GOODS,SERVICES AND INCOME


The basic aspects of economy which include production and consumption are subject to the stock and
flow concepts which are circular in nature.

THE PRODUCTION PROCESS

The process of producing goods and services involves households and


firms in a circular flow.As shown again,the economic resources of
land,labor and capital are provided by the households and used by the
producing firms.these firms in turn produce goods and services which are delivered to households for
consumption.

THE FLOW OF GOODS AMONG PRODUCING FIRMS

Within the circular flow of the production process is another flow


which happens among different types of business firms.The flow
involves raw materials,intermediate goods and final goods.

RAW MATERIALS-unprocessed goods like wood,sand and iron.


INTERMEDIATE GOODS- partially processed goods and stil needs
processing before it can be finally consumed like steel bars, flour
and microchips.
FINAL GOODS- processes goods ready for consumption like bread.

According to the types of goods they produce,firms may be


classified as follows:
1. RAW MATERIALS-like those engaged in producing agricultural products used in
manufacturing(fish,wood,sugar)
2. INTERMEDIATE GOODS-like those producing construction materials,guitar strings, and food
seasoning.
3. FINAL GOODS-like those producing chocolate
bars,refrigerators and bicycles

THE FLOW OF OUTPUT BETWEEN FIRMS AND


HOUSEHOLDS

As shown,the output of raw materials producers are delivered to


intermediate goods producers,whose output,in turn are
delivered to final goods producer,The consumers become
recipients of the
goods produced by final goods producers.

GOODS AND INCOME FLOW AMONG HOUSEHOLDS AND


VARIOUS TYPES OF PRODUCERS

Households provide producers with the economic resources


required.These resources are distributed among the various
types of producers.the producers,in turn remit payments to
households for the use of resources.
When the goods are finally processed,these are delivered
to the households,which in turn, remit their payments to
the concerned producers.

The circular flow of income is a neoclassical economic


model depicting how money flows through the
economy.In its simplest version ,the economy is modelled
as consisting only of households and firms.Money flows
to workers in the form of wages and money flows back to
firms in exchange for products.this simplistic model
suggests the old economic adage that supply creates its
own demand.

The money that is earned is used to purchased goods and


services from business such as food,clothes,rent,basic commodities,entertainment services,health and
wellness products etc.

The income earned daily flows back to business continuosly in a cycle known as the circular flow of
income.

Business an d companies manufacture goods and services to consumers. To increase sales and
profit,these companies use factors of production-labor,capital and land –to run their operations and
grow their business.In return for their services,the hired labor is given a wage or salary,known as
income.

The income received is used by households and individuals to


purchase the goods and services produced by these
business.The business use the proceeds from the sales to
produce more products and pay workers for their labor.

INCOME FLOW

When money is spent by households for consumption and by


firms for production, a circular flow of income is created.The
expenditure of one unit becomes the unit of another
unit.Income takes two distinct circular flows as follow:

THE CONCEPT OF EQUILIBRIUM


The economy will be in equilibrium if the amount received by firms from households is equal to the
amount received by households from firms.Disequilibrium
happens when either households or firms do not spend all
their incomes.If households for one reason or another
reduce their purchase firms will receive a reduced amount of
income resulting to their inability to maintain current levels
of purchases of economic resources,some labourers will lose
their job,and some land and physical capital will become
idle.The result is a corresponding reduction in the income of
households.

THE EFFECT OF SAVING AND INVESTMENT

If the total output of firms are purchased by the households and the total economic resources are
bought by firm,there is equilibrium in the market .In reality,however,households alloocte a part of their
incomes for future use like providing money for old age.As a result, disequilibrium happens because
firms are hand-pressed to dispose all their output.The circular flow will tend to contract.To prevent this
from happening,some other means for disposing the sold portion of the output must be tapped.

Investment is a way of disposing unsold output.Firms spend money to procuregoods and services for the
purpose of increasing the productive capacity in the future.In effect,Firms spend money now to
minimize their expenditures for capital outlay in the future.When the savings of the households are
matched by investments expenditure of firms disequilibrium is
negated and the circular flow of income will tend to normalize

FLOW IN A MARKET WITH GOVERNMENT AND FOREIGN


COUNTRIES
In an economy like Philippines,there are two important sectors
that interact with the households and firms : The Government
and Foreign countries.

The government sector which performs necessary fuctions buys


the economic resources of land,labor and capital from
households.Land is used by the government to locate its building and facilities;Labor is hired to fill up
various position in the different agencies;Capital is borrowed to produce the necessary facilities and
services.Payments in the form of wages,rent and interest are remitted to the households by the
government.Government money however is spent not only in buying the economic resources from
households but also the goods and serviced produced by firms.Payment are also remitted to these firms.
The foreign sector has an important role on the economy.when the domestic business firms export
goods and services to the foreign market,injctions are made into the circular flow model. On the other
hand, when the domestic households,firms or the government imports something fron the foreign
sector,leakage occurs in the circular flow model.

Each sector has dual roles to play in the economy; while sector receives certain payments from other
sectors

BASIC ECONOMIC ACTIVITIES

PRODUCTION-The use of economic resources in the creation of goods and service for the satisfaction of
human wants.
CONSUMPTION-The using up goods and services by consumer purchasing or in the production of other
goods.
EMPLOYMENT-The use of economic resources in production;engagement in activity
INCOME GENERATION-The production of maximum amount an individual can spend during a period
without being any worse off.

STOCK AND FLOW VARIABLES


FLOW –A quantity measured over a particular period of time.
STOCK-A quantity measured as of a given point in time.

The concepts of stock and flow measurements are essential in understanding the economic variables of
wealth and income.

Wealth-Anything of valued owned.It is a stock since it is what is owned at a particular time.


Income-The rate at which we earn money.It is a flow since income that is saved, increases the stock of
wealth.

TWO ECONOMIC UNITS


Household-The basic consuming unit.
Firm-The basic producing unit.

The Households delivering economic resources to the business firms for use in production because these
households are the resource owner in the economy.
They can own land , labor, and capital which they provide the firms for use in the production of goods
and services.

The different Types of Business Firms


• Raw materials are unprocessed goods like logs, wheat, and iron ore.
• Intermediate goods are also called goods in process because they have been partially processed
but are not yet ready for final use in consumption.
Some firms are raw material producing firms .they cut down lumber from the forests or explore mines
for ores. Some firms transforms these raw materials into intermediate goods.
We have firms that convert these intermediate goods into final goods, such as when firm finishes up the
car so it is ready for us to ride in.

IMPLICATION OF THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

 The goods,resources,and money payments will flow as long as household continue to


consume,and as long as firms continue to produce.
 That since goods and resources flow in exchange for payments,the rate of payments,the rate of
payments flow will in the end be the same.Money is the inducing factor,and the pillar of the
price system.without it,there is no price system.

INFLOWS AND OUTFLOWS

Outflows(factors that decrease the level of economic activity)


 Savings
 Taxes
 Imports

Inflows(factors that increase the level of economic activity)


 Investment
 Government Spending
 Exports

Outflows- are difficult to control because they are dependent on income.When income increases,we
expect savings,taxes and imports to increase.

Inflows-are easier to manipulate.The proper use of Policy enables the government to encourage exports
and investments and to increase its expenditures when it desires to expand the flow of economic
activity.

THREE SETS OF POLICY

Monetary Policy- Affects the savings and investment.


Fiscal Policy- Controls taxes and government expenditures.
Trade Policy- Affects a country’s exports and imports.

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