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Macroeconomics 1 – The domestic economy

Components of the circular flow

3.1 Consumption (C)

 The spending by people, or households

 Mainly affected by income (Y) levels

 ∆C = ∆Y × Marginal propensity to consume (MPC)

3.2 Savings (S)

 Saving is defined as the amount of income not spent.

 It is therefore sometimes regarded as a residual; the amount of income left
after consumption has been determined.

 The factors determining saving are mainly the mirror image of the factors
determining consumption.

3.3 Investment (I)

 Expenditure on investment covers:

– fixed capital formation (e.g. plant, machinery, roads, houses);

– increase in stocks of raw materials, WIP and finished goods.

 Main determinants are

– Expectations re future cash flows

– Cost of capital

3.4 Government (G), tax (T), imports (M) and exports (X)

 G and T set by government policy – see later

 Influences on (X – M) – see later

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