The Circular Flow as an Economic System
MODEL LAB · LABORATORY 01
The Circular Flow
as an Economic System.
Before an economy can be modelled, it must be represented. Discover how production, income, expenditure and finance connect households, firms, government and the rest of the world in one internally consistent system.
REAL FLOWSMONETARY FLOWS
REPRESENTATION BEFORE SIMULATION
Who acts?
What flows?
The circular flow is the smallest complete map of a macroeconomy. Every transaction has two sides: one agent pays, another receives; one account uses resources, another supplies them.
Households
Supply labour and capital, receive factor income, consume, pay taxes and save.
Firms
Combine intermediate inputs and factors to produce goods, services and investment.
Government
Collects taxes, purchases output, transfers income and provides public services.
Rest of World
Connects the economy through exports, imports, transfers and financial flows.
Capital Account
Transforms saving into investment and records net lending or borrowing.
THE ACCOUNTING CORE
Different viewpoints.
The same economy.
Y = C + I + G + X − M
Expenditure identity
Total output equals household consumption, investment, government demand and net exports.
S − I = (G − T) + (X − M)
Sectoral balances
One sector’s financial surplus must be matched by another sector’s deficit.
J = S + T + M
Injections and leakages
Investment, government spending and exports sustain the flow; saving, taxes and imports withdraw demand.
MEASURED OVER TIME
A flow
A quantity recorded during a period. Its unit includes time: euros per year, jobs created per quarter, tonnes emitted per month.
MEASURED AT A MOMENT
A stock
A quantity existing at a point in time. Flows accumulate into stocks, while stocks influence future flows.
CIRCULAR-FLOW LABORATORY
Balance the
economic system.
Change autonomous expenditure, fiscal flows and external transactions. The laboratory calculates output, leakages, injections and the implied accounting discrepancy.
420 + 95 + 120 + 135 − 150 = 620620 − 620 = 0SYSTEM READINGThe three approaches to GDP are consistent. Every recorded use of output is matched by recorded income.
THINK LIKE AN ECONOMIC MODELLER
Four disciplines of
system representation.
Define boundaries
Which agents, activities, territories and time period belong inside the model?
Preserve identities
Behaviour may change, but accounts must still balance after every simulation.
Separate identity from theory
An identity must hold by definition; a behavioural equation is a testable assumption.
Trace both sides
Every payment is somebody’s receipt; every purchase activates a corresponding supply.
SCIENTIFIC CHECKPOINT
Can you read the
circular system?
If households increase saving while investment, government spending and exports do not change, what happens initially?
Select the most defensible statement.
