Economies are dynamic – they change and react to change – look at the effect of the budget.
To understand – look at what makes up the economy.
Simplest form is a 2 sector model – only two areas: households and firms. Households own resources – these are: ??? They get paid; make no savings (no investment [yet]). Two flows – EXPLAIN.
This model is always in equilibrium.
This is an unrealistic model, we don’t consume every dollar.
Leads to 3 sector model – includes financial institutions.
We have savings and investment
Savings is LEAKAGE
Investment is INJECTION - “non-consumption” in the current time frame. It can include goods that will not be replaced for long periods.
Income (households) – consumed or saved. Y = C + S. (income = consumption + savings)
Spending (firms) is production and investment. Y = C + I. (spending = consumption + investment).
Balancing the equation means firms must estimate what households want. They get it right OR wrong. If it is right, ‘C’ of production = ‘C’ of income.
Implication: ‘S’ = ‘I’ Equilibrium
End result: Y = C + S ………..and ………..Y = C + I cancel “C’s” leaves ‘S’ = ‘I’
What if ‘S’ > ‘I’? Leakage is greater than injection.
(See example chart.)
Outcome of model: S > I, production falls, unemployment rises
National income (Y) falls.
Money in banks > money on loan; encourage more borrowing. How? Lower interest rates.
What if ‘S’ < ‘I’? Reverse cycle – production increases, unemployment drops.
National income (Y) rises.
Government sector (all layers)
Taxation is LEAKAGE.
Government spending is INJECTION. Includes benefits.
If G > T, budgetar ...