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Circular Flow of Income. How the different components of an economy interact. - YouTube
Channel: Economics Mafia
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In macroeconomics
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we study the economy of one country
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Then try to understand how 2 countries interact and trade
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And hopefully, understand the global economy
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So today, we are going to study the circular flow of income
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Let's make things really simple
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Imagine we are alone on an isolated island
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There's no government, no trade, no savings
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I told you, it's simple!
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There's only firms and households
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Firms provide households with goods and services
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Out of thin air?
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Nah..
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Firms gotta get factors of production from households
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It can be labor, land, capital or...
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Face it. Some of us in households
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are going to be entrepreneurs
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So...entrepreneurship
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For free? You wish!
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We don't get freebies from firms
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We don't provide labor for free either
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So there's money flowing in the opposite direction
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Households gotta pay firms for the goods they get
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Firms also gotta pay households in the form of
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wages, rents, interests or profits
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But this is a little weird
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We don't spend everything we earn in real life
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So let's add savings
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Savings is money we don't spend
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So there's money flowing out
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Hey, savings don't just sit in banks...
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Banks invest in firms by lending to them
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Cos firms need money to buy capital equipment
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or cover other costs of production
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So there's investments flowing into the economy
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Bravo! Awesome!
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But this is a little too simplified
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Let's add government
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Government buys stuff as well
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So there's money flowing in
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Government gets money from taxes
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Taxes?!?
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So there's money flowing out
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Cos for the money we're paying as taxes, we cannot spend it
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Lastly, countries interact with one another
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Imagine this is an American economy
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Let's add trade
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America imports stuff
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For example, America can import shoes from China
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Shoes flow from China into America
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And money spent on imports flows out of America into China
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America exports too
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America can produce software
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and export it to foreigners
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Money then flows from foreign countries into America
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This is America's export earnings
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Investments, Government Spending and Export earnings
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are called Injections
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Cos money is flowing in
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Savings, Taxes and Import spending
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are called Leakages or Withdrawals
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Cos money leaks out of the system
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And hey, Injections and Leakages are sort of related
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Investments come from Savings
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Government spending comes from Taxes
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America makes money from foreigners by Exporting
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But foreigners also make money from America when America Imports
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Wow! No wonder it's Circular Flow of Income
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It tells us roughly how an economy functions
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How do we measure the size of an economy then?
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By measuring Gross Domestic Product or GDP
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GDP is the total value of all final goods and services produced
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within the borders of a country during a given period.
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Why must it be FINAL goods and services?
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If you like this video
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remember to like and subscribe
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Next up: Measuring GDP: Output Approach
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