MEASURING

THE ECONOMY

CHAPTER

Adding the Financial Sector into the

Model
It

is unrealistic to assume that the household sector

consumes every peso of income earned on goods and

services. A portion of it is saved in some financial
institution
This act of saving is called leakage from the circular flow
or sometimes referred to as an outflow.

Adding the Financial Sector into the

Model (Cont.)
Investment is considered as injection into the circular
flow. This is because the money circulates back into the
circular flow
EXAMPLE: The business sector borrows money from
financial institutions to support the financial resources of
their own investment. Hence, the money went back to the
circular flow when they purchase economic resources

Adding the Financial Sector into the

Model (Cont.)
In case of foreign investment, it may be considered as
an injection into the country for it brings employment and
more production. However, most of these foreign
investors send back their profit to their own country and
this manifest leakage form our economy. This process is
known as profit repatriation

Adding the Government Sector into the

Model
The government sector plays a vital role in our economy.
The government imposes taxes to support a wide range
of budgetary programs.
Both household and business sectors are obliged to pay
their corresponding taxes. Therefore, tax is a leakage
from the circular flow

Adding the Government Sector into the

Model (Cont.)
The government also spends its income generated out
of the taxes paid by the household and business sectors
on salaries of public servants and capital expenditures
on road construction, repair bridges, establishment of
public

hospitals,

schools

and

the

like.

Hence,

government expenditure or spending is an injection into

the circular flow

Adding the Overseas Sector into the

Model
The Philippines has an open economy, a certain
percentage of Philippine consumption is made up of
goods and services produced overseas while some
products are being explored to other countries
Importation is a leakage in the circular flow this is
because the money that has been used to pay import
does not circulate back into the economy. Hence, an
increase in imports causes national income to fall

Adding the Overseas Sector into the

Model (Cont.)
Exportation of foods and services are considered as an
injection into the circular flow this is because the receipts
of the sales of the products return to the economy.
Hence, an increase exports results to an increase in the
national income

Circular flow of Income

The circular flow diagram shows the transactions among
households, firms, governments, and the rest of the world.

Circular flow of Income

These transactions take place in factor markets, goods
markets, and financial markets.

Circular flow of Income

Firms hire factors of production from households. The blue
flow, Y, shows total income paid by firms to households.

Circular flow of Income

Households buy consumer goods and services. The red
flow, C, shows consumption expenditures.

Circular flow of Income

Households save, S, and pay taxes, T. Firms borrow some
of what households save to finance their investment.

Circular flow of Income

Firms buy capital goods from other firms. The red flow I
represents this investment expenditure by firms.

Circular flow of Income

Governments buy goods and services, G, and borrow or
repay debt if spending exceeds or is less than taxes.

Circular flow of Income

The rest of the world buys goods and services from us, X,
and sells us goods and services, Mnet exports are X - M

Circular flow of Income

And the rest of the world borrows from us or lends to us
depending on whether net exports are positive or negative.

Circular flow of Income

The blue and red flows are the circular flow of expenditure
and income. The green flows are borrowing and lending.

Circular flow of Income

The sum of the red flows equals the blue flow.

Circular flow of Income

That is: Y = C + I + G + X - M

Gross Domestic Product

The circular flow demonstrates how GDP can be
measured in two ways.
Aggregate expenditure
Total expenditure on final goods and services equals the
value of output of final goods and services, which is GDP.
Total expenditure = C + I + G + (X M).

Gross Domestic Product

Aggregate income
Aggregate income earned from production of final goods,
Y, equals the total paid out for the use of resources,
wages, interest, rent, and profit.
Firms pay out all their receipts from the sale of final goods,
so income equals expenditure,
Y = C + I + G + (X M).

Gross Domestic Product

Financial Flows
Financial markets finance deficits and investment.
Household saving, S, is income minus net taxes and
consumption expenditure, and flows to the financial
markets;
Y = C + S + T,
income equals the uses of income.

Gross Domestic Product

If government purchases exceed net taxes, the deficit
(G T) is borrowed from the financial markets (if T
exceeds G, the government surplus flows to the markets).
If imports exceed exports, the deficit with the rest of the
world (M X) is borrowing from the rest of the world.

Gross Domestic Product

How Investment Is Financed
Investment is financed from three sources:
Private saving, S
Government budget surplus, (T G)
Borrowing from the rest of the world (M X)

Gross Domestic Product

We can see these three sources of investment finance by
using the fact that aggregate expenditure equals
aggregate income.
Start with
Y = C + S + T = C + I + G + (X M)
Then rearrange to obtain
I = S + (T G) + (M X)
Private saving S plus government saving (T G) is called
national saving.

Gross Domestic Product

GDP Defined
GDP or gross domestic product is the market value of
all final goods and services produced in a country in a
given time period.
This definition has four parts:
Market value
Final goods and services
Produced within a country
In a given time period

Gross Domestic Product

Market value
GDP is a market valuegoods and services are valued at
their market prices.
To add apples and oranges, computers and popcorn, we
add the market values so we have a total value of output
in dollars.

Gross Domestic Product

Final goods and services
GDP is the value of the final goods and services produced.
A final good (or service) is an item bought by its final user
during a specified time period.
A final good contrasts with an intermediate good, which is
an item that is produced by one firm, bought by another
firm, and used as a component of a final good or service.
Excluding intermediate goods and services avoids double
counting.

Real GDP and the Price Level

Real GDP is the value of final goods and services
produced in a given year when valued at constant prices.
Calculating Real GDP
The first step in calculating real GDP is to calculate
nominal GDP, which is the value of goods and services
produced during a given year valued at the prices that
prevailed in that same year.

GDP Formula

Formulas of Real GDP, Nominal GDP

Approaches to GDP Accounting

The National Statistical Coordination Board (NSCB) uses
the ff. approaches to GDP accounting:
a) Industrial Origin Approach or Production Approach;
and
b) Expenditure Approach

Industrial Origin Approach or Production

Approach
This approach sums up the market value of the most
comprehensive

tools

in

performance of a country.

measuring

the

economic

Industrial Origin Approach or Production Approach to GDP

Expenditure Approach
This approach sums up the expenses of the institutional
sectors: household, private corporations, government
corporations, and the general government plus their
expenditures in other regions of the world
Components of Expenditure Approach are:
1. Consumption or household final consumption expenditure (C)
2. Investment or gross domestic capital formation (I)
3. Government consumption and gross investment (G)
4. Exports (X)
5. Imports (M)

Expenditure Approach

MEASURING THE
ECONOMY

CHAPTER

THE END