CIRCULAR FLOW

OF
ECONOMIC ACTIVITY
Basic Economic Activities:
• Production – the use of economic resources in the creation of
goods and services

• Consumption – goods and services produced are ready

for use
• Employment – the use of economic resources in production.

• Income generation – the price paid to the resource owners

either by rent, interest or labor

2 Economic Units:
2. Household - the basic consuming unit
3. Firm - the basic producing unit
 The Stock and Flow Variables
Flow - a quantity measured over a particular
period of time
Stock - a quantity measured as of given point in
time
The concept of stock and flow measurements are essential in
understanding the economic variables of Wealth and Income

Wealth - anything of value owned

Income - is the flow and the rate of which we earn
money
 The Economic Model of Production

The Circular Flow of the Production Process

ECONOMIC RESOURCES

( Land, Labor, Capital)

HOUSEHOLDS PRODUCING UNITS

(FIRM)

GOODS AND SERVICES

Circular Flow of Goods and Services moves in clockwise

 Circular Flow of Goods Among Production Units
and Households
3 types of firms:
1. Raw material Firm
2. Intermediated good Firm
3. Final good Firm

Interrelation between Production Units and Households

Resources Raw Material Firm

HOUSEHOLDS Resources Intermediate good Firm

Resources Final good Firm

 Circular Flow of Income

Income Flow of Wages, Interests, Rents

HOUSEHOLDS PRODUCING UNITS

Purchase of Goods and Services

Circular Flow of Income is in counter clockwise. The flows of income and

consumption expenditures involves financial transactions because of the
payment of money.
 Circular Flows of Physical Goods and Money Income

Purchase of Goods and Services

Economic Resources

HOUSEHOLDS PRODUCING UNITS

Money Payments (Rents, Wage, Interest)

Goods And Services

 The Circular Flow of Goods and Income of Households and
Firms, with the Government and Foreign Countries

GOVERNMENT
Wages, Rents, Purchase of
Interest Goods and
Services
Purchase of Goods and Services

Economic Resources

PRODUCING UNIT
HOUSEHOLDS

Money, Payments (Rents, Wages, Interest)

Goods and Services

Money payments Money payments

for Exports for Imports
FOREIGN COUNTRIES
 INFLOWS AND OUTFLOWS

What are the Outflows in the Consumption stream?

1. Savings
2. Taxes
3. Imports

What are the Inflows in the Consumption stream?

1. Investment
2. Government spending
 OUTFLOW:
Savings:
Households do not spend all their income for consumption.
A portion of income is saved. If there are no other demand
aside from that of the household, the business firm would
not be able to sell their goods and services.
Taxes
Households have to pay the government on their income tax.
When households pay taxes, the effect is lessen disposal
income and lessen consumption
Imports
When we buy from foreign countries, the amount is spending
on the part of household. But the expenditure flows into the
foreign countries.
 INFLOW:

Investment
Money deposits in the banks are used for
investment on business firms and lending them
to people. If investments is equal to savings, it
offsets the outflow of savings.

Government Spending
Government uses the taxes collected from the
households to defray expenses in
infrastructure, social services, education and
economic development. These amounts are
spent back into the flow.
 INFLOW:

Export
Income derived from export is returned back
into the flow in the form of income to household
and business firms and taxes to the
government
Take Note:

 When OUTFLOWS is taking place in the

economy, recession of economic activity is
bound to experience
 OUTFLOWS = INFLOWS, level of economy is
maintained
 Excess INFLOWS over OUTFLOWS will be
expansionary and results in increase in level of
economic activity
 Excess in OUTFLOWS over INFLOWS will make
contracting effect and results in decrease
economic activity
 3 Sets of Policies that may be Implemented

1. MONETARY POLICY that which affects savings

and investment
2. TRADE POLICY that which affects countries
exports and imports
3. FISCAL POLICY that which controls taxes
(revenue) and government expenditure

Government applies policies in accordance with its goals.

Policy may be “EASY” when the aim is for expansion. Policy
may be “TIGHT” when there is a need to restrict the circular
flow by making less funds available to the economy.
END
 Circular Flow of Income Among Production
Units

MONEY PAYMENTS FOR RAW MATERIALS

RAW MATERIAL FIRM INTERMEDIATE GOOD FIRM

Money Payments For Intermediate

Goods

FINAL GOOD FIRM

Money Payments for Final Goods HOUSEHOLDS