Economics 9 Name___________________________________ Score ____________ 2nd Q

MODULE
5
Circular Flow of the Economy
Scope of Macroeconomics
Macroeconomics became a separate study in the field of economics during the Great Depression in the 1930s. In the 1930s,
the United States and other economies were severely weakened. Before the onset of the Great Depression, it was believed that
national production depended solely on the supply of capital, labor, and technology.
As a response, many researchers in the field of economics sought to construct a new framework. Over time, the major
policy objectives of macroeconomics took shape.
1. Macroeconomic policies aim for high level and rapid growth of output.
2. Macroeconomic policies seek high level of employment.
3. Macroeconomic policies try to achieve price stability.
The policy instruments by which the policy objectives can be accomplished include policies that affect the overall demand
for goods and services- monetary and fiscal policies. Other policy instruments, known as income policies, are direct steps such as
wage and price controls.
Circular Flow Diagrams
Circular flow diagrams show the relationship between income and expenditures. It describes all the transactions among the
different sectors the economy, namely households, firms, the government, and the foreign sector. The four sectors are connected by
three types of markets, namely, market for goods and services, market for factors of production, and the financial market.

A Simple Model
A simple model considers an economy with only two sectors (house-hold firms)
and two types of markets (market for goods and services and market for factors of
production). It illustrates the circular flow of money between households and firms. For
this economy, the total consumption spending by households equals the total income of
households.
In the market for factors of production, firms purchase factors of production
owned by households like land, labor, and capital. In the market for goods and services,
households use their earnings from selling the factors of production to buy products from
firms. Thus, money flows from firms to households, then from households to firms, and
then back to households.
Since every transaction has a buyer and a seller, every peso of spending by some
household in the market for factors of production.
The inner flows are flows of goods and services and flows of factors of
production. The household offers factors of production to firms who need them to
produce goods and services which, in turn, are bought by the households.
The outer flows are flows of money. Firm revenues from selling goods and services to the households are distributed as
payments to the factors of production owned by households.
For this economy, the total consumption spending by households, C, equals the total income of households, Y. Hence,
Y=C. If Y= P 1,000,000 then C= P1,000,000 as well.
The total flow of money represented by adding up all the consumption spending by households is total spending on goods
and services produced in the economy which is equal to the market value of all the final goods and services produced in the
economy- that is, the gross domestic product (GDP) of the economy.
For this economy, the GDP measures the total consumption spending by households on goods and services. And since the
total consumption spending by households equals the total income of households, GDP also measures the total income of
households.
Savings, Investment, and Financial Market
In figure 1, households spend all of their income on goods and services. In figure 2, households set aside apart of their
income as savings, which goes into financial markets where household savings channeled into investment spending by firms.
Investment spending by firms is spending on capital goods, such as machinery and factories.
For this economy, the sum of total consumption spending by households, C, and total investment E=Y
spending by firms, I, equals the total income of households, Y. Hence, Y= C+I. C+ S = C + I
S=I
If we add up household consumption spending on goods and services and investment spending by
firms, the total flow of money represented by this calculation is total spending on goods and services produced in the economy
which is equal to the market value of all the final goods and services produced in the economy- that is, the GDP of the economy.
For this economy, the GDP measures the total spending by households and firms. It also measures the total income of households.
Suppose that total consumption spending by households is P750, 000 and the total savings by households is P250, 000.
Thus, the P1,000,000 household income is divided into P750, 000 for spending and P250, 000 for savings. In financial markets, the
P250, 000 household savings are channeled into P250, 000 investment spending by firms.
C+ S = C + I = Y
 ₱750, 000 + ₱250, 000= ₱750, 000 + ₱250, 000 = ₱1, 000, 000
Economics 9 -page 2 of 3- 2nd Q

The Circular Flow Model with Government Sector

The household income in figure 2 is consumed and saved. In figure 3, households pay part of their income to the
government in the form of taxes. Here, household income is consumed, saved, and used to pay
taxes. The government uses its tax revenue to buy goods and pay for the services of government E=Y
employees. Thu, household tax payment is channeled into government spending on goods and C+ S + T = C + I + G
services. S+T=I+G
For this economy, the sum of total consumption spending by households, C, total S–T=G-T
investment spending by firms, I, and government spending, G, equals the total income of
households, Y. Hence, Y= C+I+G.
If we add up household consumption spending on goods and service, investment spending by firms, and government
spending, the total flow of money represented by this calculation is total spending on goods and services produced in the economy
which is equal the market value of all the final goods and services produced in the economy- that is the GDP of the economy. For
this economy, the GDP measures the total spending by households, firms, and government. It also measures the total income of
households.
Suppose that total consumption spending by households is P675, 000 total savings by household is P225, 000, and that the
total tax payments by households is P100, 000. Thus, the P1, 000, 000 household income is divided into P675, 000 for consumption
spending, P225, 000 for savings, and P100, 000 for tax payment. In financial markets, the P225, 000 household savings are
channeled into P225, 000 investment spending by firms. In the market of goods and services, the P100, 000 household tax payments
are channeled into P100, 000 government spending. The flows of money through this economy can be seen in figure 3.
C+ S + T = C + I + G
₱675, 000 + ₱225, 000 + ₱100, 000= ₱675, 000
₱225, 000 + ₱100, 000 = ₱1, 000, 000
 Economics 9 -page 3 of 3- 2nd Q
The Circular Flow Model with Foreign Sector
In figure 3, we focused only on consumption spending by households, E=Y
investment spending by firms, and government spending on goods and services. In C+ S + T = C + I + G + X - M
figure 4, we see that there are other types of spending on goods and services- imports S+T=I+G+X-M
and exports. Exports to other countries would generate a flow of money out of the S – T = (G – T) + (X-M)
economy.

If we add up household consumption spending on goods and services (C), investment spending by firms (I), government
spending on goods and services (G), and foreign spending on Philippine goods, or exports (M), the total flow of money represented
by this calculation is total spending on goods and services produced in the Philippines which is equal to the total income of
households, Y. Hence, Y= C+I+G+ (X-M).
The total spending on goods and services produced in the Philippines equals market value of all the final goods and services
produced in the Philippines-that is, the GDP of the Philippine economy. Equivalently, GDP equals the total income of households.

FT1. Write True if the statement is correct and False if it is wrong. Underline the word that makes the statement false.
1. Macroeconomics studies the economy as a whole. TRUE
2. The study of macroeconomics focuses on the behavior of households and firms. TRUE
3. If macroeconomics looks at the economy as a whole, microeconomics deals with individual units of the economy. TRUE
4. The study of macroeconomics was formed during the Great Depression. TRUE
5. All economic problems can be solved without the need for government intervention. FALSE
6. In the circular flow model, all spending ends up as income. TRUE
7. The circular flow diagram shows the transactions among the different sectors of the economy. TRUE
8. In times of globalization, an economy can be self-sufficient. TRUE
9. Exports to other countries generates a flow of money out of the Philippine economy and imports lead to flow of money into the
economy. TRUE
10. Since every transaction in the economy has a buyer and a seller, total expenditures equal total income. TRUE
FT2. Answer the following questions.
1. Look at figure 1, why is household income equal to the revenue of firms?
2. Examine figure 2, what would happen if households just keep their savings instead of putting those in bank?
3. The economy as whole can be compared to a family. Suppose that your family earns ₱20, 000. What could your family do? Explain your
answer.
FT3. Identify the concept of each statement.
1. Christelle visits this deposit cash while Cora borrows money from the same in order to start her business. BANKS
2. This sector of economy makes sure that you receive social services like free schooling, roads in good condition, clean surroundings, and
others.
GOVERNMENT
3. A country earns from selling dried mangoes to countries like Japan, Australia, and USA. EXPORT
4. EJ accepts money as payment to the services he gave to a firm. FACTORS OF PRODUCTION/ LABOR/ INCOME
5. This amount is deducted from Enrico’s salary each month as his contribution to the government fund. TAXES END