Sem 1 Lecture 2

Quensay to keynes (circular flow of goods only)

Bartering system:

• one good is traded for another, both assumed to have the same value.

Limitations of bartering and benefits of money

• Bartering limited to small population and amount of goods

• Double coincidence of wants - people trading need to have the good they want at the same time, with a high population and more goods this is difficult

• money is a medium of exchange and store of value, so many transactions can be made. Therefore fixing bartering limitations

How money eliminates circular flow of goods

• money allows for groups of goods to have certain values

• Many transactions take monetary form eg taxes

What is a circular flow?

The sum aggregate outflows must equal the aggregate sum of inflows

• injections = leakages

• As a model of aggregation and the economy as a whole, it is macro

Quensay’s circular flow model

Split french society into three classes:

• Landlords - Earn rent

• Artisans - Spend what they receive (luxury consumption)

• Farmers - Workers who save what they earn for investment

Quensay’s circular model and the stationary state

The agricultural surplus remained constant each year hence no economic growth.

If landlords consume more of their rents they the surplus will decrease

If there is tax on land then the surplus will decrease

The only way for economic growth would be through increased agricultural productivity which in turn increase the surplus

Classical economists critique of Quensay model

Believed that artisans and farmers were more than just workers

Believed that Quensay had a view that was static rather than dynamic view.

Modern circular flow (without investment)

• took agents as households and firms where an individual who consumes is a household and those who produce are a firm

• Any transaction added value

• Assumed that firms would produce only consumption goods and households would consume these with all their income

• Therefore a stationary state as Total factor income = Total consumption expenditure

Modern circular flow of income with investment

• Where households do not spend all their income and save some

• Firms now produce consumption and capital goods

• Savings now equal investment

Modern circular flow of income with investment maths

Households income Y = C + S where C = what they consume, S = savings

firms output Y = C + I where C = Consumption goods, I = Capital goods (investment)

So equating the two we get that S = I.

Modern circular flow of income with government

• added sector means that the gov tax firms and households

• this income is then spent on subsidies to firms and wages and transfer payments to households (workers in public sector and pensions, benefits etc)

• Money that is not spent by government goes into savings which then contribute to capital formations (such as hospitals, roads etc)