Cyclical Fluctuations in Income and Employment

Abstract

We look at the circular flow of income ( Y) in the economy as a whole. Firms (the producing units) pay income to households (the consuming units) whose spending on goods and services determines the receipts, and thus the profits of firms. It follows:

• 1. The equilibrium output of the economy occurs where spending on goods and services equals spending by entrepreneurs (including normal profit) on factors of production.

• 2. The level of production (and employment) is related to the level of spending.

• 3. Spending may not be sufficient to produce an equilibrium level of output where all factors are fully employed.

Assume: (a) Net profit is the gross profit less depreciation, and all depreciation retentions are spent on replacement investment, so that investment (I) is net investment; (b) all net profit is distributed, so that there is no saving by firms; (c) no government taxation or spending; (d) a closed economy; (e) no changes in the price level; (f) employment is directly proportionate to output.