6. Economic circular flows in basic text-books | 1999-06-30 To Chap 5 |
The basic text-books of macro economy show economic circular flows of about the same degree of detail as the previously described Model S2. They all have in common that the Gross Domestic Product is a single flow in the diagrams. That makes it difficult to find a place for the public production. The pictures show mainly private production of goods and services.
The book "Economics" by Lipsey et. al. (1) (my issue
is the Tenth edition 1993) is used for the basic courses of political
economy at the universities. It has a figure with the title "The
Circular flow of Expenditure and Income", shown below:
Figure 6.2:1. "The Circular Flow Elaborated". Lipsey FIGURE 3-2. and "The Circular Flow of Expenditure and Income" FIGURE 23-1.
The book comes from the USA where the opinion about the functioning
of the economy is different from that in Sweden. The figure describes
the essential features of a pure market economy. The main actors
are the households and the domestic producers. The market for
goods and services is found on the right side of the figure. That
may be the reason for placing the imports so that it looks like
the households do the importing. As far as I know, the private
imports are neglectable in comparison to the imports by the companies.
The author gathers the GDP (Total payments) in one flow in the
system. The national income (Total income generated) is gathered
in another flow. The figure does not distinguish between taxes
from households and companies. According to American ideology,
the influence of the public sector shall be as small as possible.
Maybe that's why the author has not shown the public production.
The impression is that the public sector only buys goods ("national
defense, provision of justice, the building of schools and roads")
for the tax money. The households get their social security through
their own savings. This saving is invested in the companies (shares).
The companies in the figure have no contact with the financial
system, despite that they probably save and borrow more money
than the households.
A reservation is made in a footnote and the author points out that some main flows have been omitted for simplicity: "(i) Government add directly to the incomes of the domestic households through what are called transfer payments, which include unemployment insurance and social security payments, and (ii) some of the money that firms spend on investments comes, not from the financial system, but from their own profits that they reinvest rather than paying out as dividends ".
According to a source at the USA congress, the expenses of the federal budget 1997 were distributed as:
| Social Security, Welfare, other mandatory | $837 billion |
| Interest on the debt | $248 billion |
| Defense discretionary | $266 billion |
| Non defense discretionary | $280 billion |
| Total | $1631 billion |
More than half of the federal expenditures go to social security
and welfare. It implies that the flows mentioned in the footnote
ought to be included in the figure. According to the same source,
the defense expenditures were about half of the federal budget
in the year 1962. Thus, there has been a shift from purchases
of goods to transfers during the latest 35 years. The budgets
of the states and local authorities are about half as big as the
federal budget (Chapter 22 "Taxation and Public Expenditure"
of "Economics").
The book "Vår ekonomi (Our economy)" (2) by Klas Eklund was recommended reading at the university when I took the basic course in macro economics. It has several economic circular flow diagrams with different degree of detail. The one that is most similar to the figure of Lispey and to the "Model S2" is shown below:
Figure 6.3:1. "Foreign trade in the economic circular flow", Figure 8.1 in the book by Klas Eklund.
This picture resembles very much the view of Lipsey. The foreign trade is placed in the same way, the households do the imports. The market for good and services has an important role in the system. The public sector buys goods from the market and pays transfers to the households. It would have been rather simple to include the payments of wages and salaries from the public sector (factor payments with the terminology of the figure) and emphasize that the public sector contributes to the production in the society. In that case, the gross domestic product (GDP) flow would have to be split into two places in the figure.
In order to better model the Swedish economy, one has to accept
that the production takes place in different sectors of the economy
(private and public) and that there is a market for goods and
services for the households (consumption goods) and an other market
for the companies (primary and intermediate inputs, exports and
imports).
The English book "Output, Inflation and Growth" by D.C. Rowan (3) has a rather complicated figure. The whole production is included in a single sector here too. The diagram does not include foreign trade.
 |
| Figure 6.4:1. "The circular flow of income, output and expenditure". Fig 3.iii, Output Inflation and Growth. |
The author has also in this case put the national product in one single place in the system, between the enterprises and the market. The author has excluded the public (government) sector. The national income consists of wages, rents and profits. It constitutes the total income of the households and is used for consumption expenditure and savings. The savings are used for investments in the enterprises. Consumption expenditure and investment expenditure make up the national expenditure. The production of goods and services is partly used for the consumption of the households, partly for the investments of the enterprises. The small circles are final destinations for the national product. The consumption expenditure of the households is the money paid for the consumption goods. The wages paid to the households correspond to the labor done in the production.
The author uses different kinds of arrows for money flow and goods and services flows. However, it is difficult to see the difference in the printed figure. It is more clear if the figure 6.4:1 can be split into two figures, one for payment flows and another for resources. Payment flows are expressed in currency units / time unit (e.g. dollars/year) and payment balances can be set up for each sector. Resource flows belong to the real economy and are expressed in labor units or hardware units / time unit (e.g. man-years/year or tons/year or units/year).
Many economists prefer to express real flows as currency units / time unit by applying the price as a conversion factor. Difficulties occur when inflation in the system shall be treated because the unit for real flows will not be constant.
 |
| Figure 6.4:2. Payment flows of figure 6.4:1. |
 |
| Figure 6.4:3. Resource flows of figure 6.4:1. |
A recently published book (4), "Ekonomisk teori (Economic
theory)" by Robert W Grubbström, professor of production
economy at the university of Linköping, Sweden, describes
the mathematical methods needed to analyze economic circular flows.
The book has a chapter devoted to flow diagrams. The following
diagram is found in the introduction to the book (the original
mathematical notation is excluded from the figure below):
|
| Figure 6.5:1, Robert W Grubbström: Economic theory, Figure 1.4 |
The book is limited to the treatment of consumers, producers and markets. "Goods" means goods and services delivered by the producers. The public sector is not included for the reason that: "Some economic actors do not in a simple way fit into the classification used. … The most important type of such actors are the different governmental organs, municipalities, regional governments and the state." Nor is foreign trade included. The author uses different notation for payments and real flows. The diagram will be easier to understand if two figures are used here too.
 | 
|
| Figure 6.5:2, Payment flows of figure 6.5:1. | Figure 6.5:3, Resource flows of figure 6.5:1. |
The book also describes the mathematical methods needed to analyze markets, supply and demand.