THE

CIRCULAR FLOW OF

CONOMIC ACTIVITY
Prepared by: Alamillo, Yves L. BSAE 2E1

THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

Stock and Flow Concepts The Circular Flow of Goods, Services, and Income The Production Process The Flow of Goods Among Producing Firms Goods and Income Flow Among Households and Various Types of Producers Income Flow The Concept of Equilibrium The Effect of Savings and Investments Flow in a Market with Government and Foreign Countries

The two basic activities undertaken in any activity

Production

Consumption

Stock and Flow Concepts

Stock

Refers to the measure of quantity at a point of time. It is an accumulation of a commodity like gasoline in a fuel tank.

Flow

Refers to the measure of movement of quantity over a period of time.

The Circular Flow of the Goods, Services and Income

The basic aspects of the 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 form. These firms, in turn, produce goods and services which are delivered to households for consumption.

THE CIRCULAR FLOW OF THE PRODUCTION PROCESS

LAND,LABOR,CAPITAL (Economic Resources)

HOUSEHOLDS (Resource Owners)

FIRMS
(Organizers and User of Economic Resources )

GOODS & SERVICES (Output)

The Flow of Goods Among Producing Firms

This flow involves raw materials, intermediate goods and final goods.

According to the type of goods they produce, firms may be classified as follows:
1.

Raw materials producers like those engaged in producing agricultural products used in manufacturing. Intermediate goods producers like those producing construction materials, guitar strings and food seasoning. Final goods producers like those producing chocolate bars refrigerators and bicycles.

2.

3.

THE FLOW OF OUTPUT BETWEEN FIRMS AND HOUSEHOLDS

RAW MATERIAL FIRMS
raw materials

INTERMEDIATE GOOD FIRMS

intermediate goods

HOUSEHOLDS
final goods

FINAL GOODS FIRMS

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.

HOUSEHOLDS

economics resources payment economics resources payment economics resources payment FINAL GOODS PAYMENT

RAW MATERIAL PRODUCERS

INTERMEDIATE GOODS PRODUCERS FINAL GOODS PRODUCERS

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 income of another unit.
Income takes two distinct circular flows as follows: Between household and firms, and Between firms.

The Concept of Equilibrium

The economy will be in equilibrium if the amount received by from firms from households is equal to the amount received by households.

The Effect of Savings and Investments

If the total output of firms are purchased by the households and total economic resources are bought by firms, there is equilibrium in the market.

THE CIRCULAR FLOW OF INCOME BETWEEN HOUSEHOLDS AND FIRMS

Income Flow
(wages, interest, rents)

HOUSEHOLDS

FIRMS

Income Flow
(purchase of goods and services)

RAW MATERIAL FIRMS

Income flow for purchase of intermediate goods

FINAL GOODS FIRMS

Income flow for purchase of intermediate goods

Income flow for purchase of final goods

HOUSEHOLDS

THE EFFECT OF REDUCTION OF PURCHASES

Reduced Income
(as a result of Reduced purchases of economic resources)

HOUSEHOLDS

FIRMS

Reduced Income
(as a result of reduced purchases of goods and services)

THE CIRCULAR FLOW OF GOODS AND INCOME IN A SIMPLE ECONOMY WITH SAVINGS & INVESTMENT

FIRMS
Rent, wages interest, profit Land, labor, capital

Investments Capital goods

Goods and services

payments

HOUSEHOLDS

SAVINGS

FLOW IN THE MARKET WITH GOVERNMENT AND FOREIGN COUNTRIES

In an economy like the Philippines, there are two important sectors that interact with the households and firms: the government and foreign countries. The government sector which performs necessary functions buys economic resources of land, labour, and capital from households. The goods and services purchased by the government come in a wide variety of forms: from office supplies to transport equipment and from consultancy to janitorial services. Household purchase goods and services from other countries, like transportation equipment, books, computer programs etc.

GOVERNMENT

rent, wages, interest

Land, labor, capital

payment for goods and services

rent, wages, interest

HOUSEHOLDS
goods and services
payment for imports

FIRMS

payment for goods and services

payment for exports

FOREIGN COUNTRIES