2.4: Using the circular flow model to look at the influences on economic activity (PART 1)

to understand the general gist of economic activity we need to use the circular model
Circular Flow model - illustrates how the Australian economy works and how its different parts are interrelated. Additionally it identifies some of the macroeconomic variables affecting our countries economic conditions.
The model’s five sectors
1. 1- The Household sector
  1. everyone included
  2. Some people sell their resources (natural, labour and capital) to firms and use the money to demand or buy finished goods. Helps satisfy their needs and wants.
2. 2- The Business sector
  1. purchases or demands resources from households which are then converted into finished goods and services.
  2. sell goods to the household sector
  3. households and business both act as sellers and buyers
  4. three sub sectors to the business sector; government, financial and overseas
3. 3- The financial sector
  1. made up banks, building societies, stock exchange, credit unions and finance companies.
  2. They borrow household savings (S) and lend these to people who want credit for investment and business expansion (I)
4. 4- The government sector
  1. collects revenue from taxes (T)
  2. They use this revenue to pay for government spending (G) and other funds spent on goods and services including public hospitals and schools.
5. 5- The overseas sector
  1. Buy imports to satisfy out wants (M)
  2. Sell exports overseas (X)
Using the model to outline the factors affecting economic activity
1. The model & GDP is affected by 2 things - the level of aggregate demand/aggregate supply
2. Aggregate Demand - sum of spending on goods and services produced by a nation over a year. It is made up of C+I+G-X-M
3. Aggregate Supply - total supply of goods and services that a nation can potentially produce. Especially affected by the availability of a nations resources and the efficacy with which these are used.
4. 1 - The importance of aggregate demand for the short term or cyclical level of economic activity
  1. GDP in short terms depends on AD
  2. AD is also affected by the amount leakages relative to the number of injections
  3. Increases in leakages relative to injections = decreases AD. Usually causes a contraction or slow down. falls severely, could be in recession
  4. A fall in leakages relative to injections = increase in AD. Expansions follow and could cause a boom.
5. 2 - The importance of aggregate supply for the long term structural level of economic activity
  1. Supply affects the speed limit or potential rate of economic growth.
  2. Over years, rate of growth and production levels rise.
  3. total AS of goods and services that nations can provide is affected by availability of resources and their efficiency
  4. Long term trend line slopes upwards to the right. Around 3.25% per year in Australia.

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2.4: Using the circular flow model to look at the influences on economic activity (PART 1)

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