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Video transcript

let's say that there's a country that's made up only of this island and that's sitting in the middle of the lake and on that island there's only one dude here he has one house and he has some land on which crops can be grown but he wants to think a little bit more formally about his economy and he starts setting up some institutions that start to resemble things that we would see in more complex economies so what he decides to do is he decides to set up a firm so let me put the firm right over here he decides to create a legal entity call some firm over here some corporation and he's sitting here he's the household he's a household of exactly one person so this is him as a household and he decides to give multiple factors of production to the firm so he gives factors of production to the firm so he gives he essentially rents out his building so he gives capital he rents out the land to the firm so he gets he's giving a land and he also works for the firm so he is giving labour and he is the owner of the firm and he's he was the guy who thought of this entrepreneurial activity so he's also giving the factor of production that sometimes thrown in there is entrepreneurship entrepreneurship I'll just I'll just abbreviate it just like that and in return the firm will essentially pay rents for these factors of production so the firm will pay him will pay him money in exchange for being allowed to use all of these things so for the rent on the capital on the building itself so for the building the building and we'll talk about let's say this is all in a given year for the building he the firm is going to pay him the firm that he owns is going to pay him $1,000 per year $1,000 so this is the building rent let me make it clear that this is building rent or building lease building rent it's going to pay him $1,000 for the land for the land rent he's also going to get paid another thousand dollars and then for his wages essentially the rent on his labor so his wages you could view that as and on labor they're renting his is energy in his time his wages he's also going to get $1,000 per year did I say $1,000 per month it should be $1,000 per year so he's getting $1,000 a month in building rent thousand dollars a month in land and $1,000 a month in wages and he gets whatever profit whatever profit comes from the firm because he is the owner of the of the firm and you could say that that's the compensation in exchange for his entrepreneurship so in this and looking at only this part or these two lines the household he is providing all of the factors of production for the firm so that the firm can produce useful things so the firm can produce goods and services and it's good that the firm will produce goods and services because this household needs to survive he needs a place to stay and he needs food to eat and so let's say with the labor and this land and you know so this guy is working at this farm and it has this land and all of the rest its able to produce some food and so it sells it sells him goods and services so it sells it sells this household goods and services and in particular it sells him food and it also rents out the property and I think you could see this is already getting kind of circular here he's essentially renting out his own property but this is a nice simple example obviously once you expand beyond what more than one person or more than one firm things get complicated fast so he's getting food and shelter and in exchange for the food in the shelter he's going to pay the firm in exchange for that he's going to pay the firm and so he's going to pay the firm let's just say that he decides there's it much of a market right over here he is the market but let's say for the food for the food he decides to pay he's pays $2,300 $2,300 a year for the food and for the use of the of the building that is that the firm is renting he is paying let's say he's paying $1,200 rent of $1,200 so a couple of ways to think about it you can look at it from the households point of view what are his total expenditures well total expenditures come out - what 3,500 hours so this is total let me do this in a different color this is total total expenditures for this household and what's his total income well he gets $1,000 for the building thousand dollars for land thousand dollars for wages and he gets some profit from that firm so we don't know what that profit is so look why don't we hold off a little bit on his total income so I'll just write it here total total income we don't quite know what that is yet because we have to figure out how much profit he's getting from the firm so let's look at the firm's point of view what is the total revenue that they are getting for the firm the total revenue total revenue well he's getting 20 the firm is getting twenty three hundred dollars for the food $1,200 for the rent getting total revenue of $3,500 per year everything years on an annual basis I'm a feeling I said per month by accident a few times everything here is on an annual basis getting $3,500 per year and what are the firm's expenditures well the firm has to has so this is expenses and here we're going to be thinking in terms of economic profit because we're really just thinking about how much money is coming out of this firm out of this business so expenses so for the building the building the firm has to pay one thousand dollars for the land the firm has to pay one thousand dollars and for the labor and for the labor the firm also has to pay one thousand dollars and so what's left over is the profit we're assuming that there's no taxes over here this is the profit for the owners $3,500 - three thousand gives us a profit of five hundred dollars and that's going to go to the owner of the firm who happens to be this guy right over here so the profit is five hundred dollars and so his total income is $3,500 $3,500 and it's good that his income is at least $3,500 because that's how much he's spending it per month spending per month now the whole reason why I did this is to kind of show you the circular flow of goods and services these are the goods and services up here let me show these are the goods and services goods and services the firm's provide the households goods and services and then the households are providing the firm's the factors of production and sometimes you might say well aren't other firms also providing the factors of production yes other firms could if there were other firms but those firms and the end of the day are owned by someone they are getting their factors of production by some household or they are owned by some household so you can view it as that at the end of the day the households are really giving the firm's the factors of production factors factors of production and in exchange for the factors of production the households in exchange for giving these things the firm's give the households income essentially rents on the different factors of production that are being given to the firm for the most part and over here in exchange for the goods and services the households are making expenditures that can also be considered revenue of the firm now if you are an economist that were to observe this and I guess if we were focused on this island maybe he would also have to be the island economist and you would say how would you measure how would you measure the total the total value of the product the production of my country here maybe we could call it the gross domestic product how would we measure it would you count just the total expenditures or would you count the total expenditures and the total income or would you even count that and the revenue well if you can at all of that you would be essentially triple counting if you counted the total revenue the total expenditures and the total income they're all that $3500 you would be triple counting so what you could do you could just measure only one of these things you could say your GDP your gross domestic product your gross domestic product is the total expenditures by the households so it would be the $3,500 you could say it is the total income by the households so that would also be $3,500 and the total revenue really is the same thing as the total expenditures so the whole point of this video and this is obviously a very artificial case where we're dealing with an island with only one person and he's essentially renting out his own labor but by using this firm is some type of a vehicle he's he's consuming his own labour he is renting out a house from a firm that he has rented his house to so is very very very circular but hopefully this appreciate you kind of appreciate how the resources are going around in this kind of a circular flow