Circular Flow of Income

Production Possibility Frontier

Over View


Circular flow Three Market Arenas Aggregate demand

Business Economics/Circular Flow-Prof. Monica Gupta

Over View


Aggregate supply Production Possibility Frontier Pareto Optimality

Business Economics/Circular Flow-Prof. Monica Gupta

Circular Flow of Income



A diagram showing the income received and payments made by each sector of the economy. Real flow Money flow

 

Business Economics/Circular Flow-Prof. Monica Gupta

Four Components
   

Households Firms Government Rest of the World (ROW)

Business Economics/Circular Flow-Prof. Monica Gupta

ROW

Consumer Expenditure

Firms

Goods and Services (GAS) Factors of Production (FOP) Wages interest dividend profits rent

Households

Government
Business Economics/Circular Flow-Prof. Monica Gupta 6

Unique Features
 

Leakages Withdrawals Additions Injections

 Households

Every transaction must have two sides. Govt. and house holds also import.
Business Economics/Circular Flow-Prof. Monica Gupta 7

Unique Features
 

Factor market Commodity market

Business Economics/Circular Flow-Prof. Monica Gupta

The Three Market Arenas

1.

The Goods Market Labor Market

and

Service

2.

3.

Money (Financial) Markets

Business Economics/Circular Flow-Prof. Monica Gupta

The Goods and Service Market

Demand Supply
1.

Households Firms Government ROW

Firms ROW

2.

Business Economics/Circular Flow-Prof. Monica Gupta

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The Labor Market

Demand Supply
1.

Firms Government ROW

Households ROW

2.

Business Economics/Circular Flow-Prof. Monica Gupta

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The Money Market Funds

Demand Supply
1.

Households Firms Government ROW

Households ROW

2.

Business Economics/Circular Flow-Prof. Monica Gupta

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The Money Market Features

Activity

Borrow

Lend

Business Economics/Circular Flow-Prof. Monica Gupta

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The Money Market Features

Promissory Note Treasury Bond/Bill Corporate Bonds Interest

Shares

Dividend

Business Economics/Circular Flow-Prof. Monica Gupta

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Aggregate Demand


The total demand for GAS in an economy.

Business Economics/Circular Flow-Prof. Monica Gupta

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Aggregate Supply


The total supply for GAS in an economy .

Business Economics/Circular Flow-Prof. Monica Gupta

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Aggregate Demand and Supply Curves

AS
Overall Price level P

P* AD Y* Aggregate Output Y
Business Economics/Circular Flow-Prof. Monica Gupta 17

Production Possibilities Model



The production possibilities frontier shows the combination of output that the economy can possibly produce given the available factors of production.

Business Economics/Circular Flow-Prof. Monica Gupta

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Assuming
Level of factors of Production Fixed Technology

Business Economics/Circular Flow-Prof. Monica Gupta

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Production Possibilities Frontier

Quantity of Computers Produced Scarcity Trade offs 3000 2,200 2,000 D 1,000 E 600 700 1,000 Quantity of Cars Produced 300
Business Economics/Circular Flow-Prof. Monica Gupta 20

F A

C Efficient Production B

Production Possibilities Frontier

Quantity of Computers Produced Opportunity Cost Economic Growth 3000 2,200 2,000 1,000 E 600 700 1,000 Quantity of Cars Produced
Business Economics/Circular Flow-Prof. Monica Gupta 21

F A B G

Production Possibilities Frontier

Quantity of Computers Produced Choose between A and B or any point on frontier. 3000 2,200 2,000 1,000 E 600 700 1,000 Quantity of Cars Produced
Business Economics/Circular Flow-Prof. Monica Gupta

F A B

1. Government 2. Markets 3. Both

Economic Growth
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Vilfredo Pareto Pareto Optimality



A test of economic system is when it permits all its citizens to maximize satisfaction (Welfare).

Conditions (Optimize):Distribution between consumers Allocation of productive recourses The output of goods
Business Economics/Circular Flow-Prof. Monica Gupta

Pareto Optimal Welfare Condition

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Pareto Optimal Welfare Condition



An allocation of resources is pareto efficient for a given set of consumer tastes, resources and technology, if it is impossible to move to another allocation which would make some people better off and nobody worse off. D to A is Pareto improving
Pareto Optimal Welfare Condition
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Business Economics/Circular Flow-Prof. Monica Gupta

Economic Concepts


Scarcity Trade Offs Efficiency Opportunity Cost Economic Growth Welfare

Business Economics/Circular Flow-Prof. Monica Gupta 25

Thank you

Business Economics/Circular Flow-Prof. Monica Gupta

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