Homework 2

Part 1.1

Why must the vertical columns sum to zero?

The vertical columns must sum to zero because the change in the amount of money held must always be equal to the difference between receipts and payments. Hence, within a household, the difference is between household receipts and payments and for the government it’s the difference between government receipts and outlays.

Part 1.2

Why must the horizontal rows sum to zero?

The horizontal rows must sum to zero because within the matrix, it is implied that supply equals demand. For example, in the consumption row, the sale of household consumption (+Cd) is naturally equal to the purchase of that consumption (-Cs), where Cd = Cs. This is shown by the Circular Flow of Income theory which implies that ‘everything comes from somewhere and everything goes somewhere’.

Part 2 - Explanations for each row

Consumption

Consumers have a need or demand for products and services. They purchase these products with their income (-Cd).
Producers provide what is needed or demanded by consumers and this generates income (+Cs).
Thus products or services purchased by the consumer are supplied by producers and the –Cd & +Cs terms will sum to zero.

Govt Exp

Government expenditure is similar to consumer or household expenditure in that the government spends its income on products or services (e.g. roads and make-up for Bertie), -Gd.
The producers provide these products and services and derive their own income from it. +Gs.
+Gs & -Gd terms will sum to zero.

Output

Output is the sum of all the production on goods and services in an economy by the production sector. It is not a transaction between two sectors and hence only appears once, in the production column. Total production is defined in a standard way used in all national accounts either as the sum of all expenditures on goods and services or as the sum of payments of factor income.
It is represented by Y = C + G, indicating the goods and services consumed by households and the government.

Factor Income

Factor Income represents the cost and supply of labour in an economy. The household sector provides labour to the production sector. This provides income to the households in terms of wages, +W.Ns. Labour is required in order to produce goods and services and this labour is an expenditure for the production sector, -W.Nd.
The sum of household wages and labour cost is zero; +W.Ns – W.Nd = zero

Taxes

Household income(e.g. wages) is taxed by the government. This is represented by –Ts in the household column. This tax is collected by the government and is represented by +Td. Naturally tax paid out by households equates to the tax collected by the government and +Td – Ts equals zero.

Change In Money Stock

Households accumulate excess cash over time and use it to purchase assets (e.g. Government bonds). In the simplified model the supplier of these financial assets is the government. By issuing these assets, the government can raise income to fund their public works.

References:

1. Godley, W., and M. Lavoie (2007)

2. Wikimedia, Consumption (Economics), http://en.wikipedia.org/wiki/Consumption_%28economics%29

3. Glossary of Political Economy Terms, Dr. Paul M. Johnson, http://www.auburn.edu/~johnspm/gloss/money_stock