Jim’s Notes

Circular Flow and Macro Concepts

Key Macro Concepts

Stocks and Flows

Stocks measure Wealth (at a point in time)

‘Stocks’ are variables that measure wealth or indebtedness at a point in time
‘stock’ variables in the accounting world are shown on a balance sheet, a statement of assets (valuable things owned) vs. liabilities (debts owed).
Net assets or net wealth consists of the difference between assets and liabilities.
Examples of assets (a stock): houses, ownership of business firms, inventory, cash on hand, bonds owned, anything you have a legal right to own and eventually sell.
Examples of liabilities (also a stock): debts owed, bonds issued and sold, mortgages
note: loans are liabilities of the person who borrowed the money and must eventually repay, but the loan is an asset of the person who lent the money and will get eventually repaid.

Flows measure income or payments (over some period of time)

‘Flows’ are transactions or the sum of transactions that occur between different parties over time.
in the accounting world, ‘flows’ are shown on income statements or cash flow statements
Not all flows involve cash payments. Income, spending, and saving all involve money transactions. But consumption and depreciation represent flows that reflect the ‘using-up’ or destruction of an asset by using it.
Flows represent changes in stock balances
Example: You earn cash income (flow) which adds to your bank account balance (stock). You spend money (a flow) to buy food and it reduces your bank balance.
Example: receiving income (a flow in) will increase your cash asset balance (a stock); while spending (a flow out) will reduce your cash balance but adds to the asset of food in the refrigerator (a stock). Then you eat dinner, consuming your food (a flow) which reduces the asset of food in the refrigerator.

Money Isn’t Real

Money is a place-marker of value. It is not naturally occurring.

money represents a promise of real value to be delivered at a different time.
all ‘money’ is in fact, just credit – promises to pay or deliver value in the future.

Real vs. Nominal Values

Nominal values are those monetary values actually observed in transactions at some point in time.
Real amounts represent values in terms of comparable goods as if money had kept a constant value over time.

The Product of a Nation is the best way to measure the economy (a flow)

Welfare of a nation is best measured by it’s production of goods and services to support consumption.

economic activity as flow
best measure of economic welfare of a nation is GDP: Gross Domestic Production, a flow variable.

Wealth in the macro only matters to the degree it represents potential future production, not as a goal itself

in the micro, increasing wealth is often a goal of individual agents

Circular flow of output and income

National income accounting system ( 920)

Two Key Identities

Equilibrium when Expected = Actual

Circular Flow of Economy

Households

Firms

Government

Central Bank

Private Banks

ROW

Markets

Goods and Services Markets

Resources/Factor Markets

Asset Markets

Four Sectors:

Private

Government

Financial

International

Identities:

Budget constraints (money in = money out)

households
firms
private banks
ROW

Markets: (money paid = value sold)

Goods markets
Resources markets
financial markets (money lent = money borrowed)

Government budget constraint :

purely voluntary and policy decision if sovereign fiat currency issuer
if not a currency issuer, then govt budget constraint holds:
G + transfers = taxes + gov borrowing

National Income = Production and Savings-Investment Identities:

National Expenditure on Production (GDP) = C + I + G + (X – M)

National Income available to households (GDI) = C + S + T

GDP = GDI,

National Saving – Investment Identity: therefore: C + I + G + (X-M) = C + S + T
Simplifing and rearranging: (S-I) = (G-T) + (X-M)
rephrased: net private savings (accumulation of financial assets) = government budget balance + foreign trade balance
in other words, the private sector cannot as a whole get financially wealthier unless government runs a budget deficit and/or a trade deficit.