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A nation's GDP measure's the value of its output of goods and services in a particular period of time. Gross Domestic Product is expressed in dollar terms, which means that if the price of goods and services rise, a country's nominal GDP figure will increase.

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Measuring GDP using the Income Approach and the Expenditure Approach - HD

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GDP is generally understood to represent the health of a nation's economy, and most people realize that if GDP is growing, things are going well, while if it's falling things have turned sour in the economy. But what, precisely, does GDP measures?

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The business cycle model is one often referred to in the media, which likes to use terms like "boom' and 'bust'. It is a model that can communicate several important pieces of information about a nation's economy. Basically, the business cycles is a graph which shows the level of real GDP over time.

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1. Objectives are the goals of government policy

2. Instruments are the means by which these aims might be achieved

For example, the government might want to achieve an objective of a low rate of price inflation. The main instrument to achieve this are changes in monetary policy interest rates, since 1997 they have been set by the Bank of England. Fiscal policy could be another instrument to achieve this aim. This is in the hands of the government. Supply-side policies can also be used to control inflation and promote growth over the longer-term.

The government might have another objective to make the distribution of income more equal. It would then choose the policy instruments it thinks are best suited to reaching to this aim, perhaps a change in the income tax system or a rise in the national minimum wage.

The main policy instruments available to meet macroeconomic objectives are

Monetary policy -changes to interest rates, the supply of money and credit and also changes to the value of the exchange rate

Fiscal policy - changes to government taxation, government spending and borrowing

Supply-side policies designed to make markets work more efficiently

Objectives of UK Macroeconomic Policy
The key objectives for the UK are:

Stable low inflation - the Government's inflation target is 2.0% for the consumer price index.

Sustainable growth - growth of real gross domestic product - sustainable in keeping inflation low and reducing the environmental impact of growth.

Improvements in productivity - this is designed to improve competitiveness and global trade performance

High employment - the government wants to achieve an increase employment and eventually a situation where all those able and available can find meaningful work

Rising living standards and a fall in relative poverty - cutting child poverty and reducing pensioner poverty.

Sound government finances - including control over state borrowing and the total national debt

What is meant by macroeconomic stability?

Economic stability occurs when there is low volatility in key indicators such as prices, jobs, economic growth, interest rates, investment and trade.

All countries experience an economic cycle which tracks the fluctuations in the rate of growth of a country's Gross Domestic Product, some countries have a more volatile cycle than others

Macro stability is shown in particular by the volatility of a country's economic cycle. The chart below tracks the annual % change in real GDP for the UK economy including forecasts made at the time of the March 2016 Budget.

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Macroeconomic Objectives and Macro Stability | tutor2u Economics

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Objectives are the goals of government policy Instruments are the means by which these aims might be achieved For example, the government might want to achieve an objective of a low rate of price inflation. The main instrument to achieve this are changes in monetary policy interest rates, since 1997 they have been set by the Bank of England.

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Objective: To understand how productive resources, goods and services and money flow from households to firms and from firms to households through voluntary exchanges in a nation's product and resource markets.

Introduction: This lesson simulates the circular flow of resources, goods and services in a nation with a closed economy and no government sector. The simple circular flow model re-created through this simulation can be graphically represented as follows:

Instructions: The teacher will need to prepare several resources before beginning the simulation. These include:

Money certificates: These should be printed on green paper (perhaps four certificates per page), then cut into strips approximately the size of a dollar bill. I recommend four "bills" from each sheet of paper. You'll need a paper cutter to quarter the photocopied sheets once they're printed. You should print at least 50 sheets of money, creating a total of 200 money certificates. On each certificate should be printed the words:

"This certificate is a money payment for a good or service or a productive resource. In the resource market it represents the wages, interest, rent and profits households receive as income for their resources. In the product market it represents the expenditures households make for goods and services."

Resource certificates: On a different color sheet of paper, make approximately 40 copies of a page with the three resources on it, separated vertically: "Land, Labor, Capital". Each resource should be on its own strip of paper. Make sure you create the same number of each of the three resources. For a class of 20 students, I would recommend making at least 50 copies of each resource (50 lands, 50 capitals, 50 labors, totaling 150 resources in total).

Product certificates: On yet a different color sheet of paper, print and make approximately 15 copies of a page with the words "Goods and Services" on it four times from top to bottom, so you have a total of 60 "Goods and Services" certificates. Again, use the paper cutter to quarter the pages so you have 60 strips with the words "Goods and Services" on them.

For a class of 20 students, you must create 20 different paper clipped bundles ahead of time. 10 of your students will be "FIRMS" and 10 will be "HOUSEHOLDS". Each of the households will receive a bundle of resource certificates. Each firm will receive a bundle of money certificates.

10 Household bundles: Prepare 10 bundles of resources. Each bundle can contain a random combination of land, capital,and labor. It is important that some households receive far more productive resources at the start of the simulation than others. For example, you may give one student a bundle with 5 labors, 7 capitals and 8 lands. Another student may receive a bundle with 2 labors, 1 land and 1 capital. This may seem "unfair", but will play an important role in your post-simulation debrief. Be sure to use ALL of the resources you printed out, so you are sure there is an even number of land, capital, and labor.

10 Firm bundles: Each firm is run by an entrepreneur. The entrepreneurs who manage each firm start with a different quantity of financial capital. Divide your 200 money certificates into 10 different bundles, some containing larger amounts of money than others. The "average" entrepreneur will have 20 money certificates to start, but be sure to give some firms far more than this and other firms far less.

The simulation: For the simulation, you will need a large open space. I recommend going outside where there are some trees you can tape signs to, or in a gym or a classroom with the desks moved to the center of the room.

1. Begin by asking students "Who are the two 'stakeholders' in a nation's economy portrayed in the circular flow model?" Once they've identified "Firms" and "Households", have a volunteer tape two signs on walls opposite from one another in your teaching area.

2. Next ask students to identify what it is that firms demand from households, and what it is that households demand from firms. Once they've identified "Resources" and "Products", have a volunteer tape the signs for "Resource Market" and "Product Market" opposite each other in your area. You now have four signs taped to the wall: "Households" and "Firms" are across from one another, and "Resource Market" and "Product Market" are across from one another.

3. Next assign roles: Give each student a letter, either and "H" or an "F". Half the class will become Households and will re-group at their sign, the other half of the class will be come Firms and meet at their sign. Explain to the Firms that they are entrepreneurs who want to start a business that will produce a good or service. As entrepreneurs, they are putting their own creative ideas towards a business venture, but must acquire land, capital and labor in order to begin producing their good or service.

4. Ask the Households what they want, and where they will get it. They'll say "Products" and they'll get them in the "Product Market". Ask firms what they want and where they'll get them. They should say "resources" and they'll get them in the "Resource Market".

5. Next discuss the motives of firms and households. The entrepreneurs and their firms are seeking to maximize profits in the Product Market, which they will do by minimizing their costs in the Resource Market. Therefore firms must try to acquire the land, labor and capital at the lowest cost possible and then sell their goods and services for the highest price possible. Households are seeking to maximize their incomes in the resource market in order to maximize their consumption of goods and services in the product market. Therefore households should try to sell their resources for the highest price possible and buy their products at the lowest price possible.

6. Ask the students: "Now we're ready to begin our circular flow, but something is missing. What is it?". They will know right away that "MONEY" is missing. At this time, distribute the different sized bundles of money to the entrepreneurs. Make each entrepreneur count his or her money so it knows how much it started with. This way each firm will know whether it earns a profit or a loss during the simulation.

Time to FLOW! First comes the RESOURCE MARKET. In order to produce one product, business owners must acquire three resources: one land, one capital and one labor. Make sure they know that they must have one of each to produce one good or service, so that firms do not go out an buy nothing but labor or nothing but capital.

1. The firms and the households must now meet in the resource market.

2. Give the firms five minutes to bargain for and acquire as many resources as they can from household with their limited financial capital.

3. Encourage firms to "shop around" until they find a household willing to sell its resources for the lowest cost, or until households find a firm offering the highest income.

4. Once a firm runs out of money, have the entrepreneur come to the "FACTORY" (this is you, the teacher) where the firm will exchange the resources it acquired in the resource market for "Goods and Services" certificates. Remember, one product (G&S certificate) costs three resource certificate, one of each of Land, Labor and Capital.

5. After 5 minutes the resource market is closed and firms must report to the teacher's "factory" to turn their newly acquired resources into Goods and Services. Give each entrepreneur one "G&S certificate" for each bundle of land, labor and capital the entrepreneur acquired in the resource market. Households should return to their sign and count their money incomes and drool in anticipation as the firms produce their goods and services. Any resources unsold by households or unused by firms must be put aside, these may not be exchanged in the product market.

Time for the PRODUCT MARKET.

1. Remind the households what their motive is in the product market: to acquire the MOST goods and services possible, therefore spend all their money but try to get the lowest price possible.

2. Remind firms what their motive is. EARN A PROFIT! To do this they must now sell their products at the highest price possible.

3. Give the students five minutes to buy and sell goods and services. Encourage the households to "shop around" for bargains. Observe what prices products are selling for between different buyers and sellers.

4. At the end of five minutes, the product market is closed. Send firms back to their sign and households back to their sign.

Analyzing the results:

1. First ask the firms to count their earnings. Determine which firms earned profits and which firms earned losses.

2. Determine how many resourced went unsold in the resource market or were bought by firms and then were unable to be used to produce goods and services.

3. Determine how many goods and services went unsold in the product market. If all goods and services were sold, then determine how much money households had left over and were unable to spend.

Simulation debrief - Economic concepts to discuss: The following are just some of the economic concepts that you can discuss following your circular flow simulation. There may be others, but these are some of the most interesting and important.

The Circular Flow: Ask students what, exactly, was "flowing" in the circular flow.

Resources flowed from households to firms, were turned into goods and services, which then flowed from firms to households.

Money flowed in the opposite direction; first from households to firms in the form of Wages, Interest, Rent and Profit (the income payments for the four resources households owned), then from households to firms in the form of expenditures on goods and services, which translate to revenues from firms.

Efficiency and the PPC: Were there resources that households had in the beginning but were unable to sell in the resource market or resources that firms bought but were unable to use? The existence of unused resources is evidence that our "economy" was producing below its PPC.

Discuss with the class how the "unemployed or underemployed resources" represent an "excess supply" of productive capacity in the economy. The existence of unused resources is evidence that the price in the resource market was too high! If the price had been lower, then firms would have demanded a greater quantity of resources and this "excess supply" would have been eliminated.

The unused resources represent the inefficiency of the nation's economy. If the market had been more efficient, then more resources would have been employed by firms and more goods and services could have been produced, meaning the economy would have been producing closer to its PPC.

Households with unemployed resources represent unemployment in the economy. There were mismatches in the resource market between firms and households, and the prevailing income level was too high, resulting in an excess supply of resources, i.e. a surplus of land, labor and capital.

Equilibrium price in the product market: It is possible that following the product market round, some households will have money left to spend yet firms will be sold out of goods and services. This is evidence that the price goods were going for was too low.

If households were willing and able to buy, but there was not enough product to sell, then we had excess demand in the product market. The quantity demanded exceeded the quantity supplied.

The price in the product market was too low. A price below equilibrium leads to shortages. If firms had known there would be households willing to buy, then they would have charged a higher price and the shortage would have been eliminated.

Inequalities in the distribution of income: Ask students why some households ended up with more goods and services in the end than others? Also, why did some firms end up with greater revenues than others?

Some households had higher incomes and thus enjoyed greater levels of consumption because they were endowed with higher quality and a greater quantity of resources to begin with. This is representative of the real world in which not all households have the same education levels, own the same amount of land or have the same amount of financial capital as others. Those with the greatest quality and quantity of resources earn higher incomes in the form of wages, rent and interest and therefore enjoy a higher level of consumption.

Some firms ended up with higher revenues than others, which is probably because they started with greater financial capital. The entrepreneurs with access to more financial capital when starting their business were able to produce more products and earn higher revenues. But an entrepreneur's having access to more money in the beginning did not guarantee he or she would earn profits! It's likely that even the smallest firms were able to earn profits, if they were good at negotiating their costs down and their prices up.

Competition and "creative destruction": Some firms will make losses while others make profits.

Firms that earn big losses will be forced to shut down or become smaller, because they'll be unable to buy as many resources nor produce as much output in the next round of the circular flow.

Firms that earn larger profits will be able to expand and grow since they can reinvest their profits into more inputs and greater output in the future.

Competition forces firms to be as efficient as possible. Only firms that produce in the lowest cost manner can survive in a market economy. This is good because it assures that resources will not be wasted and output will be maximized as firms pursue their ultimate motive of profit maximization. I call this Economic Darwinism: "survival of the most efficient", a key characteristic of market economies.

Other possible questions for discussion: The following questions can be distributed to students following the simulation and assigned as a reflection for the next class period, or put on the board and discussed as a class.

1. What, exactly, "flows" in the circular flow?

2. How is money spent by firms in one market end up being earned by firms in the other market?

3. What are the objectives of firms and households in a market economy?

4. Why did some households end up with more goods and services than others? Why did some firms end up with higher revenues or profits than others?

5. What role does self-interest play in a market economy?

6. What role does money play in the a market economy?

7. What would happen to the prices of resources and products if in the next round the amount of money firms started with doubled? What would happen if the amount of money were reduced by half?

Final thoughts: I have done this circular flow activity countless times with both AP and IB Econ students. Over the years it has evolved each time I've done it. I recommend you try it with your students and make small changes where you see they're needed. Throughout the AP or IB course, however, I always find myself re-visiting our circular flow simulation in lectures, and students always recall immediately what I am referring to since they themselves were the households and firms engaging in voluntary exchanges motivated by their own pursuit of self-interest.

Additional note (and an acknowledgement): My teaching partner and occasional contributor to this blog, Joe Hauet, had the idea of giving the Firm owners the "entrepreneur" badge. My original simulation had "entrepreneurship" as one of the four resources owned by households and sold to firms in the resource market. But Joe keenly pointed out that in fact all firms are ultimately owned by households, and that it is the entrepreneurs who start the firms and then must acquire additional land, labor and capital from households to produce their product. So thanks to Joe for helping make this simulation better!

About the author: Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate's Economics for the IB Diploma and REA's AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

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Lesson Plan - the Circular Flow simulation

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ShareObjective: To understand how productive resources, goods and services and money flow from households to firms and from firms to households through voluntary exchanges in a nation's product and resource markets. Introduction: This lesson simulates the circular flow of resources, goods and services in a nation with a closed economy and no government sector.

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unit 2 economics online course powerpoints

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Y1/IB 1) Government Macro Objectives (Inflation, Unemployment, Growth and Trade)

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AS/IB 2) The Circular Flow of Income - An understanding of the 4 sector circular flow of income with leakages and injections Twitter: https://twitter.com/econplusdal Facebook: https://www.facebook.com/EconplusDal-1651992015061685/?ref=aymt_homepage_panel

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This video introduces the circular-flow model of the economy and discusses some of its notable features.

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Circular flow of income and expenditures | Macroeconomics | Khan Academy

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It shows flows of goods and services and factors of production between firms and households

The circular flow shows how national income or Gross Domestic Product is calculated

Businesses produce goods and services and in the process of doing so, incomes are generated for factors of production (land, labour, capital and enterprise) - for example wages and salaries going to people in work.
Leakages (withdrawals) from the circular flow
Not all income will flow from households to businesses directly. The circular flow shows that some part of household income will be:

1.Put aside for future spending, i.e. savings (S) in banks accounts and other types of deposit

2.Paid to the government in taxation (T) e.g. income tax and national insurance

3.Spent on foreign-made goods and services, i.e. imports (M) which flow into the economy

Withdrawals are increases in savings, taxes or imports so reducing the circular flow of income and leading to a multiplied contraction of production (output)

Injections into the circular flow are additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output.

1. Capital spending by firms, i.e. investment expenditure (I) e.g. on new technology

2. The government, i.e. government expenditure (G) e.g. on the NHS or defence

3. Overseas consumers buying UK goods and service, i.e. UK export expenditure (X)

An economy is in equilibrium when the rate of injections = the rate of withdrawals from the circular flow.

Building up the model
In this next series of images we build up the circular flow model from just having a domestic sector and then adding in an external sector (exports and imports) before including the financial sector which channels savings and hopefully provides the finance available to fund investment.
The Domestic Circular Flow of Income and Spending
The external sector involves businesses exporting goods and services overseas (X) and consumers and business buying imported products from other countries (M)

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Understanding the Circular Flow of Income and Spending | tutor2u Economics

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It shows flows of goods and services and factors of production between firms and households The circular flow shows how national income or Gross Domestic Product is calculated Businesses produce goods and services and in the process of doing so, incomes are generated for factors of production (land, labour, capital and enterprise) - for example wages and salaries going to people in work.