Applied Economics

Governor Pack Road, Baguio City, Philippines 2600

Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 8 – Applied Economics Subject Teacher:

Circular flow of income

Learning Objectives:
At the end of this module, student must be able to:
a) define what is macroeconomics;
b) enumerate the economic goals and issues facing most economies today;
c) explain the concept of macroeconomics, inflation, deflation, labor force and
unemployment; and
d) explain the circular flow of income.

Macroeconomics is the study of the relationship of the broad economic sectors which make of
the entire national or global economy. It includes the aggregate supply and aggregate demand
and uses average, general absolute price levels. Microeconomics, on the other hand studies
decision- making of individual economic units, such as one producer or one household.

I. COMMON ECONOMIC GOALS

a. Economic growth – increase in the number of goods and services produced in the country
b. Economic development- improvement in the quality of life of the people
c. Full employment- the presence and availability of jobs for those who are able and willing to
work
d. Economic efficiency- achieving the maximum fulfilment of wants using the available product
resources
e. Price stability- absence of wide fluctuation in prices
f. Economic freedom – the freedom to do economic activities within the legal framework of
the economy
g. Economic security- the assurance of the fulfillment of economic needs of every member of
the society, including the handicapped

II. MAJOR ISSUES THAT COUNTRIES ARE CONTINUOUSLY TRYING TO RESOLVE:

A. INFLATION
It is the sustained increase in the general level of prices of goods and services in the economy. It is
not just a one- time increase in the general prices but a continual rise of price levels over a period
of years. The rate of inflation, which is the rate of the general price levels over a period is
measured by considering price indices.

Three Strains of Inflation:

1. Moderate Inflation – characterized by slowly rising prices. It implies relatively stable prices that
encourage people to hold on to money.
2. Galloping Inflation – this is characterized by double- or triple – digit percentage increase in
inflation rate annually. Galloping inflation may cause major economic distortions in a
country. People would prefer not to hold money; instead they convert their money into
foreign currency such as US dollars. This situation would further devalue money and decrease
interest rates, which would have negative effects on businessmen and financial institutions.
3. Hyperinflation – this is characterized by extremely high rates of inflation (as high as 1000
percent annually). This definitely does not bring about any growth for the economy, since
everyone is affected and money seems to have no value at all.

B. DEFLATION
Deflation occurs when prices are observably declining overtime, the opposite of inflation. In
economics, deflation is a decrease in the general price level, or a rise in the purchasing
power of money with respect to a large class of goods or services.

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 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 8 – Applied Economics Subject Teacher:

C. UNEMPLOYMENT
o Labor force in the Philippines – refers to the part of our population whose ages ranges from
15 to 64 yrs. old, who are willing and able to work.
o Participating labor force – actually working and contributing positively to the economy
o Non- participating labor force – not working but belongs to the age range

 Unemployment – absence of available jobs for those who belong to the participating labor
force
 Underemployment – part of the labor force who are gainfully employed, but receive
compensation as shown by their need for additional jobs or additional working hours. Usually
the underemployed are significantly underpaid (based on their commensurate
remuneration) and/ or those who work longer hours for the same pay.

Types of unemployment
1. Frictional
- A situation when workers left their jobs and are looking for new ones
2. Structural
- Happens when there are available and willing workers but their skills and training are not
those required by the business firms
3. Disguised
- Happens when the productivity of the working force is very low because the number of
workers is more than what is optimally desired
4. Seasonal
- Results from workers being unable to find continuous employment in industries where, due to
seasonal conditions, there are distinct production periods

D. ECONOMIC PRODUCTIVITY AND DEVELOPMENT

o Gross National Product (GNP) (Gawa Ng Pinoy)

-market value of final goods and services domestically and internationally produced by residents
of a country. It includes the GDP plus the factor income from abroad, less income earned in
the domestic economy remitted abroad
o Gross Domestic Product (GDP) (Gawa Dito sa Pinas)
- The total final output of goods and services produced by the country’s economy, within the
country’s territory, by residents and nonresidents, regardless of its allocation between
domestic and foreign claims

III. THE CIRCULAR FLOW OF INCOME

Circular Flow of Income shows how the goods and services are distributed among the different
sectors of the economy. It has evolved from the barter economy and is presently based on
capitalistic system. It has evolved from the barter economy and is presently based on
capitalistic economic system. The economic evolution also shows the development of two
basic flows, a) the real flow or flow of goods, service and resources and b) the money flow,
which is generated when money becomes the medium of exchange. It also shows the growth
of additional sectors in the economy. This evolution is illustrated below.
 HH – represents the Household Sector, composed of all consumers
 BS – represents the Business Sector or the Private Sector
 IS – represents the Investment Sector or the Financial Sector in an economy (i.e. banks,
insurance companies, lending firms, etc.)
 GS – represents the Government Sector, including all agencies and corporations
 ROW – represents the REST of the WORLD or the FOREIGN SECTOR

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 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 8 – Applied Economics Subject Teacher:

1. The First Level of the Economy

Illustration: In a barter economy, there is a need for a double

coincidence of wants for exchange to take place.
Household has the means of production (CELL). Companies
use the means to produce goods and services. The
household receive money in exchange for the means of
production. Rent for land, wages for labor and interest and
dividend for money. On the other hand, household
purchase the goods and services from the companies, for
which they pay the company. While money flows around
while there is goods and services exchanged.

To understand the terms on the following diagrams, the following defines the terms used:
Injections (money flows in the economy) Leakages (money flows from the economy)
- Government spending - Taxes
- Export - Import
- Investments - Savings

Factors from the Circular Circular Flow of Income

o Income (Y) - Wages, dividend & interest that go from business and
financial institutions to households
o Savings (S) -Savings from consumers, companies or the government
that flows to financial institutions
o Expenditure (E) -Consumer spending, money that flows from household to
businesses
o Taxation (T) -Taxes that go to the government from household and
businesses
o Investment (I) -Investments (loans) from financial institutions in business, to
consumers or the government
o Governement -Government spending on businesses in the form of
Spending (G) contracts or towards households in the form of wages for
civil servants, or benefits
o Import (M) -Expenditure of companies, government and consumers
abroad (money flows from the economy)
o Export (X) -Income from the sale of goods and services abroad
(money flows in the economy)
2. The Second Level of the Economy
When household save, their expenditure on goods and services will decline to the extent and
as a result, money flow to the business will contract.
With reduced money receipts, firms will hire fewer
workers (or lay –off some workers) or reduce the factor
payments they make to the suppliers of factors such as
workers.
This will lead to the fall of total incomes of the
households. Thus, savings reduce the flow of money
expenditure to the business firms and will cause a fall in
the economy’s total income. Economists therefore call
savings a leakage from the money expenditure flow.
But savings by households need not lead to aggregate
spending and income if they find their way back into
the flow of expenditure with the existence of financial institutions such as banks, insurance

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 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 8 – Applied Economics Subject Teacher:

companies, financial houses and stock markets. It is assumed though that all savings of households
come in the financial market and no inter- household borrowings.
It is business firms who borrow from the financial market for investment in capital goods such
as machine, factories, tools and trucks. Firms spend on investment in order to expand their
capacity in the future thus the savings of the household deposited in the financial market are
brought into the expenditure stream and as a result total flow of spending does not decrease.
3. The Third Level of the Economy

It can be noticed that the government’s entry

in the economy injects government spending
while the leakage is the taxes. The taxes
which comes from the household are spent
for the same sector.

4. The Fourth Level of the Economy

The fourth illustration shows that the

flow of income in all developed and
developing countries that adhere to the
democratic flow ideology. In this case, import
payments represents the leakage, while
export earnings represent the injection.

Although the model tries to show the

flow of income as fully as it could, it still has
limitations, some of which are as follows:
o It assumes that the income received is
totally spent by all sectors
o It doesn’t show direct transaction between the government and the foreign sector
o It doesn’t show labor services transaction between the household and the ROW
o It doesn’t show household to household transaction
o It doesn’t show other incomes received by the other sectors
o It doesn’t show the details of the transactions between and among sectors

Despite these limitation, the four sector model, (i.e. the real flow), becomes the basis of the
quantitative measurement of the national income.

References:
1. Rachelle de Guzman, et al (2013). General Economics. Meycauayan City, Bulacan: IPM
Publishing.
2. Caoile, P. V. (2017). Applied Economics. Quezon City: Phoenix Publishing House, Inc.
3. Azarcon, e. a. (2008). Principles of Economics. Baguio City: Valencia Book team.

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 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 8 – Applied Economics Subject Teacher:

Activity 8: Crossword Puzzle

Read the following descriptions below. Identify the concept or term being described/defined and
write the correct answers on the respective boxes. Encoded or handwritten (17 items, 1 point each)

4 6

1 3

3 4

2 7

7 5

Across:
1. Government Sector
2. Unemployment during a specific season
3. Source of income
4. Taxes, import and savings
5. Opposite of inflation
6. An example of outflow in the economy
7. Sector that has the means to production
8. Export and investments
9. Leakage in the third level of the economy

Down:
1. Unemployment where the productivity of the working force is very low
2. Who are willing and able to work
3. Implies relatively stable prices that encourage people to on to money
4. Government spending, export, taxes
5. Income from the sale of goods
6. Income Sector
7. The total final output of goods and services produced by the country’s economy, within
the country’s territory
8. Business Sector

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“Obstacles don't have to stop you. If you run into a wall, don't turn around and give up.
Figure out how to climb it, go through it, or work around it.”
Michael Jordan

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