Worth: Mankiw Economics 5e 2 The data of 117 g he Circular Flow This Income(S) figure illustrates the flows between firms and households nomy that produces good, bread, fre inner loop represent the flows of labor and bread. households sell their labor to firms and the firms sell the bread Household they produce to loop represents the corresponding flows of dollars: households pay the firms for the bread and the firms pay wages Goods(bread Expenditure(S economy, GDP is both the total expenditure bread and the total income from the production of bread from these sales to pay the wages of their workers, and the remainder is the profit belonging to the owners of the firms(who themselves are part of the household sector). Hence, expenditure on bread flows from households to firms, and in- come in the form of wages and profit flows from firms to households GDP measures the How of dollars in this economy. We can compute it in two ays. GDP is the total income from the production of bread, which equals the sum of wages and profit-the top half of the circular flow of dollars. GDP is also the total expenditure on purchases of bread--the bottom half of the circular How of dollars. To compute GDP, we can look at either the flow of dollars from firms to households or the fow of dollars from households to firms These two ways of computing GDP must be equal because the expenditure of buyers on products is, by the rules of accounting, income to the sellers of those products. Every transaction that affects expenditure must affect income, and every transaction that affects income must affect expenditure. For example, suppose that a firm produces and sells one more loaf of bread to a household Clearly this transaction raises total expenditure on bread, but it also has an equal effect on total income. If the firm produces the extra loaf without hiring any more labor(such as by making the production process more efficient), then profit increases. If the firm produces the extra loaf by hiring more labor, then wages increase In both cases, expenditure and income increase equally User JOENA: Job EFF01418: 6264_ch02: Pg 17:24935#/eps at 1004 IlmI Tue,Feb12,20028:404MUser JOEWA:Job EFF01418:6264_ch02:Pg 17:24935#/eps at 100% *24935* Tue, Feb 12, 2002 8:40 AM from these sales to pay the wages of their workers, and the remainder is the profit belonging to the owners of the firms (who themselves are part of the household sector). Hence, expenditure on bread flows from households to firms, and in￾come in the form of wages and profit flows from firms to households. GDP measures the flow of dollars in this economy. We can compute it in two ways. GDP is the total income from the production of bread, which equals the sum of wages and profit—the top half of the circular flow of dollars. GDP is also the total expenditure on purchases of bread—the bottom half of the circular flow of dollars.To compute GDP, we can look at either the flow of dollars from firms to households or the flow of dollars from households to firms. These two ways of computing GDP must be equal because the expenditure of buyers on products is, by the rules of accounting, income to the sellers of those products. Every transaction that affects expenditure must affect income, and every transaction that affects income must affect expenditure. For example, suppose that a firm produces and sells one more loaf of bread to a household. Clearly this transaction raises total expenditure on bread, but it also has an equal effect on total income. If the firm produces the extra loaf without hiring any more labor (such as by making the production process more efficient), then profit increases. If the firm produces the extra loaf by hiring more labor, then wages increase. In both cases, expenditure and income increase equally. CHAPTER 2 The Data of Macroeconomics | 17 figure 2-1 Income ($) Labor Goods (bread ) Expenditure ($) Households Firms The Circular Flow This figure illustrates the flows between firms and households in an economy that produces one good, bread, from one input, labor. The inner loop represents the flows of labor and bread: households sell their labor to firms, and the firms sell the bread they produce to households. The outer loop represents the corresponding flows of dollars: households pay the firms for the bread, and the firms pay wages and profit to the households. In this economy, GDP is both the total expenditure on bread and the total income from the production of bread