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Introduction to Macroeconomics
The Components of the Macroeconomy: The Circular Flow

Macroeconomics focuses on four groups: households and firms (which together make up the private sector), government (the public sector) and the rest of the world (the international sector). These four groups interact in a number of ways.

The Circular Flow Diagram

Any market economy comprises the interactions of households, firms, the government, and other nations. We have discussed the interaction of two of these components, households and firms, in the lecture for chapter 3. There, we introduced the circular flow between the input and output markets. Now, let us add the other components of the economy to the circular flow diagram.

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The Circular Flow of Payments

The figure above shows that households work for firms and the government, receiving wages in return for supplying labor. In addition, households receive interest payments, dividends, profits, and rent from firms on their investments in stocks and bonds, ownership of companies, and land used by firms. Households also receive interest from the government from purchases of government bonds and transfer payments (Social Security, welfare, and others).

The diagram also shows that firms and households pay taxes to the government. Moreover, it illustrates that households, the government, and foreigners purchase goods and services from firms. Finally, it shows that households purchase goods and services from foreigners.



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