Working the Financial Markets

• Savers and Buyers: On one side of the financial markets, savers in the household sector buy legal claims and in so doing divert income to the financial markets. They give up income in exchange for the legal claims to the ownership of physical assets or to future repayment of income.


• Borrowers and Sellers: On the other side, borrowers in the business and government sectors sell legal claims and in so doing obtain income from the financial markets that they use to undertake expenditures. The borrowers give up legal claims in exchange for income.

Spending More, Taxing Less

The federal level regularly borrows to finance the federal deficit by issuing Treasury securities. State and local governments also borrow needed funds. Local communities finance school buildings, street construction, and other capital improvements by borrowing. State governments borrow to finance public capital projects, such as university buildings and highway construction.

Government borrowing is quite common because the voting public tends to favor lower taxes, but more government spending. They enjoy the public goods provided by the government sector, but would rather not pay the necessary taxes. If taxes fall short, then borrowing is the only answer.

The Circular Flow

The Circular Flow

A basic representation of the circular flow is displayed to the right. The components of this model are the four macroeconomic sectors--household, business, government and foreign--and the three macroeconomic markets--product, resource, and financial.

The household sector at the far left contains the consuming population of the economy. The business sector at the far right includes all of the producers. The government sector is positioned in the middle of the diagram and the foreign sector is at the very top.

The product markets near the top of the flow direct production from the business sector to the household sector in exchange for payment flowing in the opposite direction. The resource markets at the bottom of the flow direct factor services from the household sector to the business sector in exchange for payment flowing in the opposite direction. The financial markets located just above the resource markets divert saving from the household sector to business and government borrowing.

The circular flow indicates that the income used by the household sector to purchase goods through the product markets is obtained by selling factor services through the resource markets. It also indicates that the revenue used by the business sector to pay for factor services obtained through the resource markets is generated by selling goods through the product markets.