[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

DEMAND AND EQUILIBRIUM OUTPUT
For the product market to be in equilibrium, the supply of goods and services produced
by firms in the economy must balance with the demand for the economy’s
goods and services. Firms will not continue to produce at the full-employment level
if their products go unsold. If the economy is to maintain full employment, the total
level of demand in the economy must adjust to balance output at full employment.
The economy’s financial sector—what we called the capital market in Chapter 1—
plays a critical role in achieving this balance. By examining that role, we can see
more clearly how the interrelation of markets helps ensure macroeconomic
equilibrium.
A useful starting point in understanding how demand adjusts to equal fullemployment
output is the circular flow of income. Figure 24.6 shows the circular
flow of income for a closed economy. Notice that we have ignored the government
sector for the moment.
The circular flow diagram illustrates the flow of goods and income that links
households, business, and financial sectors. In the diagram, the purple lines indicate
flows of real resources and goods and services; the green lines represent the
payments for those commodities. Households supply resources (labor, capital, land)
Goods purchased
Households
Labor supplied
Payment
for goods
Saving
Profits and
interest
income
Wage
income
Product Market
Capital Market
Labor Market
Firm
revenue
Investment
funds
Profits and
interest
payments
Wage
payments
Goods produced
Firms
Labor hired
Figure 24.6
THE CIRCULAR FLOW
OF INCOME
The circular flow of income provides a summary picture of how the flows of commodities
and payments link the household and firm sectors of the economy. Households provide
resources, such as labor, to firms and receive income payments in return. They use this
income to purchase goods and services in the product market. The revenue that firms
obtain from selling in the product market enables them to make the income payments
to households for the labor and other resources that they have used. Saving from the
household sector flows into the capital market, where it is available to firms that wish to
borrow for investment projects.
534 ∂ CHAPTER 24 THE FULL-EMPLOYMENT MODEL