Macroeconomics

• Macroeconomics studies the economy as a whole and is concerned with the overall performance of the economy. Macroeconomics focuses on why the economy grows and why economic activity fluctuates over time.
• The circular flow of income is a macroeconomic model that describes the flows of resources, goods and services, and income between the parts of the economy.
• Sectors in circular flow of income model:

  1. households
  2. firms
  3. financial sector
  4. government
  5. overseas sector
• circular flow of income ~ five sector model

  
• The economy is a continuous flow of money, goods, services and productive resources between people that make them and people that want to buy them
• Households are the owners of the productive resources (land, labour, capital and enterprise); and the buyers of final goods and services.
• Firms are the employers of the resources and produce all goods and services for the economy. All output produced is sold to consumers.
• The simple model has two flows – a real flow of goods, services and resources, and a money flow of spending and income
• Factor market (top flows) - households receive income in the form of wages, rent, interest, dividends, and profits from the resources they supply to firms for use in the production process.
• Product market (bottom flows) - households spend their income in exchange for goods and services that have been produced by the firms sector.
• In the factor market, firms hire resources (natural, human and capital) from households, in return for which households receive income.
• Most households receive the majority of their income in the form of wages or salaries earned from working but some earn rent in return for productive land they hire to producers, some invest money capital in companies in return for dividends, some lend surplus money to borrowers in return for interest, and others sell their enterprise in return for profit.
• In the product market, households and business firms spend the income they have earned on goods and services produced by business firms.
• The circular flow of income model reminds us that people in modern economies are interdependent – we all depend on one another to provide the goods and services that satisfy out wants and needs. Very few people in the modern economy can claim to be self-sufficient.
• Saving is the portion of household income not spent on goods and services for current consumption
• Households deposit their surplus funds into financial institutions (banks, credit unions and superannuation funds)
• The financial institutions form the capital market or financial sector
• Savings represents a leakage from the circular flow because it reduces the flow of money and goods between households and firms
• Investment is defined as expenditure on goods and services which are not intended for current consumption
• Investment is the purchase of capital equipment to be used in production. This includes spending by firms on productive equipment and machinery and spending on buildings and factories
• Investment leads to increased production of final goods and services for consumers in the future.
• Investment expenditure creates an increase in the flow of income in the future. Investment is an injection that offsets the savings leakage in the circular flow.
• Financial sector

  
• The government plays a significant role as both a consumer and producer.
• In Australia, the government employs 18% of the workforce and has become responsible for the provision of social welfare (pensions, job search allowance and childcare allowance). In economics, these are called transfer payments.
• Government also regulates many aspects of economic activity so that commerce runs smoothly and equitably.
• Households pay some of their income to the government (the taxation leakage) which is returned to the flow through government expenditure.
• Many of the collective goods and services our community needs are provided by the government sector, which raises most of its revenue from taxation.
• Wages and salaries attract income tax, business firms pay a tax on profits, and certain types of consumption expenditure attract taxes, such as sales and excise duties and Goods and Services Tax (GST).
• Like savings, taxation is a leakage from the real and money flows between households and firms. Government spending is the corresponding injection into the flow of income and goods.
• Government spending can be classified as current expenditure (spending on current goods and services such as wages and salaries, fuel, power and stationery) or capital expenditure (spending on capital or investment goods which are sometimes called infrastructure – schools, roads, railways and hospitals).
• Government sector

  
• All households spend some of their income on goods and services imported from overseas. Similarly, people in other countries purchase Australian-made goods and services.
• An open economy is an important contributor to our economic wellbeing – trade allows us to buy items we cannot produce ourselves, and foreigners to buy products they cannot produce with their resources.
• Imports are a leakage and exports are an injection.
• A transaction is classified as an import when the money flows from Australia to overseas.
• A transaction is classified as an export when the money flow from overseas to Australia.
• Overseas sector

  
• Aside from the real and money flows that constitute the simple circular flow, the full model recognises that:

  1. A capital market (financial sector) exists to match the needs of households with surplus income and firms that wish to borrow for investment.
  2. The government sector provides many community needs, financed by taxation.
  3. Trade with other countries provides for the needs we cannot produce ourselves in return for goods and services that are surplus to our needs.
• The model gives us an overview of the interdependence between the major sectors of the economy.