Circular flow, GDP and the business cycle

Learning objectives

Use the circular flow model to show how households, firms, government, the financial sector and the rest of the world are linked by flows of spending and income, including leakages and injections

Define gross domestic product (GDP) and calculate it by the expenditure approach (C + I + G + Xn) and the income approach, explaining why the two must give the same total

Decide what is and is not counted in GDP: final versus intermediate goods, second-hand sales, purely financial transactions, transfer payments, and non-market or illegal production

Explain the limitations of GDP as a measure of well-being, including income distribution, leisure, environmental damage and non-market activity

Distinguish nominal from real GDP, use the GDP deflator to convert between them and calculate growth rates of real GDP

Describe the phases of the business cycle (expansion, peak, contraction, trough), distinguish actual from potential output and identify positive and negative output gaps