The Circular Flow The Circular Flow Model and the Market Model and the Market

SystemSystem

Circular FlowCircular Flow

You decide to by a car so you go to the You decide to by a car so you go to the dealer and exchange money for the car. dealer and exchange money for the car. The dealer has rented land and buildings The dealer has rented land and buildings while also hiring workers to produce the while also hiring workers to produce the cars. The employees earn income for their cars. The employees earn income for their labor and use that income to buy food from labor and use that income to buy food from the grocery store. This transaction the grocery store. This transaction generates revenue for the grocery store, generates revenue for the grocery store, which also hires workers and pays them which also hires workers and pays them income that they then use to purchase income that they then use to purchase goods and services. Your expenditure for goods and services. Your expenditure for the car is part of a circular flow.the car is part of a circular flow.

Circular Flow continuedCircular Flow continued

Now, complicating the prior story is the Now, complicating the prior story is the fact that some car's are made in Japan fact that some car's are made in Japan and then shipped to the U.S. Your and then shipped to the U.S. Your purchase also creates revenue for the purchase also creates revenue for the manufacturer in Japan, who pays manufacturer in Japan, who pays Japanese workers to produce car's. Japanese workers to produce car's. Also, when you buy a car, you must pay Also, when you buy a car, you must pay a tax to the government, which uses a tax to the government, which uses tax revenues to pay for police tax revenues to pay for police protection, national defense, and other protection, national defense, and other servicesservices

The Market SystemThe Market System

Consumer Sovereignty-Consumer Sovereignty-

Consumers exercise so much power b/c Consumers exercise so much power b/c the name of the game for businesses is the name of the game for businesses is profit and the only way they achieve profit and the only way they achieve this is by satisfying consumer wantsthis is by satisfying consumer wants

Consumer PowerConsumer Power

In the 1950’s and 1960’s people were In the 1950’s and 1960’s people were eating out more then ever. They wanted eating out more then ever. They wanted more restaurants and fast-food outlets.more restaurants and fast-food outlets.

As a result McDonalds, Wendy’s, White As a result McDonalds, Wendy’s, White Castle, Pizza Hut, Godfathers Pizza, Big Castle, Pizza Hut, Godfathers Pizza, Big Boy’s and other fast-food outlets flourished.Boy’s and other fast-food outlets flourished.

By the 1970’s the average number of By the 1970’s the average number of meals per person eaten out daily exceeded meals per person eaten out daily exceeded one (excluding meals prepared at home one (excluding meals prepared at home and eaten elsewhere)and eaten elsewhere)

Profit and Allocation of Profit and Allocation of ResourcesResources

When a good or service has profit potential When a good or service has profit potential someone with entrepreneurial ability will someone with entrepreneurial ability will put together the resources needed to put together the resources needed to produce that gizmoproduce that gizmo

Hopefully they sell their gizmos for more Hopefully they sell their gizmos for more then they paid for land, labor, capital. then they paid for land, labor, capital. (that's profit)(that's profit)

If the entrepreneur loses money they may If the entrepreneur loses money they may opt to stop producing that goodopt to stop producing that good

The resources then used in the losing The resources then used in the losing operation are available for an activity of operation are available for an activity of possible higher value (see book pages 74 possible higher value (see book pages 74 and 75)and 75)

The Flow of ResourcesThe Flow of Resources

Resources naturally flow from an activity Resources naturally flow from an activity where they have a relatively low value to and where they have a relatively low value to and an activity with a higher value (ex, rubber sole an activity with a higher value (ex, rubber sole shoes go out of style and the rubber is now shoes go out of style and the rubber is now used to produce a new popular brand of tires)used to produce a new popular brand of tires)

Adam Smith described this phenomenon in his Adam Smith described this phenomenon in his 1776 treatise (essay) “The Wealth of Nations,” 1776 treatise (essay) “The Wealth of Nations,” saying it was as if an invisible hand reached saying it was as if an invisible hand reached out and guided resources to their most valued out and guided resources to their most valued use (more on Adam Smith page 77)use (more on Adam Smith page 77)

Adam SmithAdam Smith

The Flow of ResourcesThe Flow of Resources

Firms produce goods and services Firms produce goods and services and use the resources that enable and use the resources that enable them to generate the highest profitsthem to generate the highest profits

Firms often mimic other firms who Firms often mimic other firms who are generating a higher profitare generating a higher profit

If a firm cannot compete with others If a firm cannot compete with others firms in the same industry it will go firms in the same industry it will go out of business and possibly move to out of business and possibly move to another area line of businessanother area line of business

McDonalds Dollar MenuMcDonalds Dollar Menu

Many other fast food chains copied Many other fast food chains copied McDonaldsMcDonalds

The Flow of ResourcesThe Flow of Resources

Because goods are produced in the least Because goods are produced in the least costly manner, consumers will more often costly manner, consumers will more often pay a low price for the goods that they pay a low price for the goods that they desiredesire

The Determination of The Determination of IncomeIncome

Consumers dictate what is produced and Consumers dictate what is produced and the search for profit defines how goods the search for profit defines how goods and services are produced.and services are produced.

Now, for whom are goods and services Now, for whom are goods and services produced?produced?

Income is obtained by selling the services Income is obtained by selling the services of resourcesof resources

The Determination of The Determination of IncomeIncome

Labor=Labor= land= land= Capital= Capital= Entrepreneurs= Entrepreneurs= This shows us that buyers and sellers This shows us that buyers and sellers

of goods and services and resource of goods and services and resource owners are linked in the economyowners are linked in the economy

Linkage of SectorsLinkage of Sectors

Household sector= Household sector= Business sector= Business sector= International sector=International sector=

* These three sectors constitute the * These three sectors constitute the ______________ of our economy*______________ of our economy*

HouseholdsHouseholds

A unit of housing may be a house, an A unit of housing may be a house, an apartment, even a single living room apartment, even a single living room as long as it constitutes separate as long as it constitutes separate living quartersliving quarters

Can consist of family members or Can consist of family members or college students sharing an apartmentcollege students sharing an apartment

Householder-Householder-

HouseholdsHouseholds

HouseholdsHouseholds

There are more than 100 million There are more than 100 million households in the U.S.households in the U.S.

The largest number of householders fall The largest number of householders fall between the ages of 35 and 44between the ages of 35 and 44

Householders between the ages of 45 and Householders between the ages of 45 and 54 have the largest median income 54 have the largest median income (roughly $ 60,000)(roughly $ 60,000)

Median is the middle value- half of the Median is the middle value- half of the households make more than $60,000 and households make more than $60,000 and half make lesshalf make less

Size Distribution of Size Distribution of HouseholdsHouseholds

26

33

17

14

72 1

One Person

Size Distribution of Size Distribution of HouseholdsHouseholds

In the U.S. the average number of people per household is In the U.S. the average number of people per household is 2.22.2

Worldwide, average household size in high-income Worldwide, average household size in high-income countries (those with an average per capita income over countries (those with an average per capita income over $9,000 per year) is near that of the U.S; that of middle and $9,000 per year) is near that of the U.S; that of middle and low income countries is more than twice as largelow income countries is more than twice as large

Per capita income-Per capita income-

Household SpendingHousehold Spending

Household spending is calledHousehold spending is called

Spending in the household sector is Spending in the household sector is the largest component of spending in the largest component of spending in the economy (roughly $6.7 trillion in the economy (roughly $6.7 trillion in 2000)2000)

We consume housing, transportation, We consume housing, transportation, food, entertainment, and other goods food, entertainment, and other goods and servicesand services

Consumer SpendingConsumer Spending

Business FirmsBusiness Firms

May be conducted at more than one May be conducted at more than one locationlocation

The terms The terms companycompany, , enterpriseenterprise, and , and businessbusiness are used interchangeably are used interchangeably with with firmfirm

Forms of Business Forms of Business OrganizationsOrganizations

Sole Proprietorship-Sole Proprietorship-

Partnership-Partnership-

Forms of Business Forms of Business OrganizationsOrganizations

Corporation-Corporation-

Multinational Business-Multinational Business-

Big Business Big Business

Very important in the U.S.Very important in the U.S. There are many small firms, but large There are many small firms, but large

firms and corporations account for the firms and corporations account for the greatest share of business revenuegreatest share of business revenue

Many more sole proprietorships than Many more sole proprietorships than corporations, but corporations make corporations, but corporations make 15x’s the revenue15x’s the revenue

(see handout and book statistics page (see handout and book statistics page 81)81)

Big Business is a global phenomenon Big Business is a global phenomenon

Worlds Ten Largest Public Worlds Ten Largest Public Corporations (2008)Corporations (2008)

1) Royal Dutch Shell (Netherlands)1) Royal Dutch Shell (Netherlands) 2) Exxon Mobil (U.S.)2) Exxon Mobil (U.S.) 3) Wal-Mart Stores (U.S.)3) Wal-Mart Stores (U.S.) 4) BP= British Petroleum (Britain)4) BP= British Petroleum (Britain) 5) Chevron (U.S.)5) Chevron (U.S.) 6) Total (France)6) Total (France) 7) Conoco Phillips (U.S.)7) Conoco Phillips (U.S.) 8) ING Group (Netherlands)8) ING Group (Netherlands) 9) Sinopec (China)9) Sinopec (China) 10) Toyota Motor (Japan)10) Toyota Motor (Japan) http://money.cnn.com/magazines/fortune/global5http://money.cnn.com/magazines/fortune/global5

00/2009/snapshots/6388.html00/2009/snapshots/6388.html

Top Ten Corporations (oil)Top Ten Corporations (oil)

Top Ten (not oil)Top Ten (not oil)

Business SpendingBusiness Spending

Investment-Investment-

Economics definition of investment is Economics definition of investment is different then the everyday definition different then the everyday definition (financial transaction such a buying bonds (financial transaction such a buying bonds or stocks)or stocks)

Investment spending in 2002 reached Investment spending in 2002 reached $1,588 billion (equal to ¼ of consumption $1,588 billion (equal to ¼ of consumption or household spending)or household spending)

International SectorInternational Sector

Foreign buyers and sellers have a Foreign buyers and sellers have a significant impact on economic significant impact on economic conditions in the U.S. (example, conditions in the U.S. (example, foreign exchange rates can affect the foreign exchange rates can affect the demand for U.S. goods)demand for U.S. goods)

Current Exchange RatesCurrent Exchange Rates http://www.x-rates.com/http://www.x-rates.com/

Types of CountriesTypes of Countries

Industrial and DevelopingIndustrial and Developing Developing countries greatly outnumber Developing countries greatly outnumber

industrial countriesindustrial countries World Bank-World Bank-

The World Bank groups countries The World Bank groups countries according to their per capita income according to their per capita income (income per person)(income per person)

Types of Countries (cont.)Types of Countries (cont.) Low income economies (per capita income Low income economies (per capita income

less than $755.00) heavily concentrated in less than $755.00) heavily concentrated in Asia and AfricaAsia and Africa

Middle income economies (per capita Middle income economies (per capita income of $756.00 to $9,265.00)income of $756.00 to $9,265.00)

High income economies such as oil High income economies such as oil exporters or market industrial economies exporters or market industrial economies (per capita income $9,266.00 or higher) (per capita income $9,266.00 or higher)

Some countries are not members of the Some countries are not members of the world bank so they are not categorizedworld bank so they are not categorized

Page 86-87 in textbook outline global Page 86-87 in textbook outline global incomeincome

““Industrial Market Industrial Market Economies” Economies”

Page 88 shows the 23 industrial Page 88 shows the 23 industrial market countries as of 2003 (per market countries as of 2003 (per capita income)capita income)

1) Switzerland $36,9701) Switzerland $36,970 2) Japan $35,9902) Japan $35,990 3) Norway $35,5303) Norway $35,530 4) United States $34,8704) United States $34,870 5) Denmark $31,0905) Denmark $31,090

““Industrial Market Industrial Market Economies”Economies”

These countries are highly These countries are highly interdependent (economic conditions interdependent (economic conditions in one country spread to others)in one country spread to others)

As a result these countries must pay As a result these countries must pay close attention to each others close attention to each others economic policieseconomic policies

Not on the list are high income oil Not on the list are high income oil exporting countries like Libya, Saudi exporting countries like Libya, Saudi Arabia, Kuwait (World Bank considers Arabia, Kuwait (World Bank considers these countries to still be developingthese countries to still be developing

Developing CountriesDeveloping Countries

U.S. imports agricultural produce and U.S. imports agricultural produce and minerals from developing countriesminerals from developing countries

Imports-Imports-

U.S. exports many manufactured U.S. exports many manufactured goods to these countriesgoods to these countries

Exports-Exports-

U.S. ImportsU.S. Imports

Imports from China have grown 665 percent Imports from China have grown 665 percent since 1992. Imports from Mexico have grown since 1992. Imports from Mexico have grown 343 percent over the same period. 343 percent over the same period.

The U.S. is the world's largest market for The U.S. is the world's largest market for exporting countries. In 2004, it imported exporting countries. In 2004, it imported more than $1.3 trillion worth of more than $1.3 trillion worth of merchandise. Of the total 2004 U.S. imports, merchandise. Of the total 2004 U.S. imports, half came from the four top trading partners: half came from the four top trading partners: Canada (17 percent), China (13 percent), Canada (17 percent), China (13 percent), Mexico (11 percent), and Japan (9 percent).Mexico (11 percent), and Japan (9 percent).

U.S. ImportsU.S. Imports

U.S. ExportsU.S. Exports

International Sector International Sector SpendingSpending

U.S. activity with the rest of the world U.S. activity with the rest of the world includes U.S. spending on foreign goods includes U.S. spending on foreign goods and foreign spending on U.S. goodsand foreign spending on U.S. goods

As of 2003 Canada and Japan played a As of 2003 Canada and Japan played a huge role in U.S. trade (roughly 1/3 of huge role in U.S. trade (roughly 1/3 of exports and more than 1/3 of imports)exports and more than 1/3 of imports)

U.S. trade with industrial countries is U.S. trade with industrial countries is approximately twice as large as trade approximately twice as large as trade with developing countrieswith developing countries

International Sector International Sector SpendingSpending

Trade Surplus-Trade Surplus-

Trade Deficit-Trade Deficit-

Net Exports-Net Exports-

Prior to the 1960’s the U.S. exported more than it Prior to the 1960’s the U.S. exported more than it imported, but since 1976 net exports have been imported, but since 1976 net exports have been negative (U.S. has been in a trade deficit)negative (U.S. has been in a trade deficit)

Linking the SectorsLinking the Sectors

See page 124 circular flow diagram See page 124 circular flow diagram and/or handoutand/or handout

Financial Intermediaries-Financial Intermediaries-

Circular Flow-Diagram-Circular Flow-Diagram-