Let's say, that there's a country that's made up only of
this island that that's sitting in the middle of the lake
and on that island there is 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 called
some firm over here, some corporation
and he's sitting here. He's the household.
He's the 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 land
and he also works for the firm, so he is giving labor
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's sometimes
thrown in there as 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, the firm is going to pay him,
the firm that he owns is going to pay him $1000 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 is going to pay him $1,000.
For the land ... For the land rent, he's also going to get paid
another $1,000 and then for his wages,
essentially the rent on his labor,
so his wages, you could view that as a rent on labor.
They're renting his ... his energy and his time.
His wages, he's also going to get $1,000 per year.
Did I say a $1,000 per month?
It should be $1,000 per year.
So he's getting $1,000 a month in building rent,
$1,000 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 ... in the ... Looking at only this part
or these two lines, the household ... He is providing
all of the factors of production for the firm,
so 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 firm and it has this land
and all of the rest, it's able to produce some food.
And so it sells ... It sells him goods and services.
So it sells ... It sells his 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 essentailly renting out his own property,
but this is a nice simple example.
Obviously, once you expand beyond one ... 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 and 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 isn't 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 pays $2,300. $2,300 a year for the food
and for the use 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 household's point of view.
What are his total expenditures?
Well, total expenditures come out to what? $3,500.
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,
$1,000 for land, $1,000 for wages and he gets
some profit from that firm.
So we don't know what that profit is,
so 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're getting?
For the firm, the total revenue ... total revenue.
Well, he's getting 20 ... The firm is getting $2,300
for the food, $1,200 for the rent,
getting total revenue of $3,500 per year.
Everything here is on an annual basis.
I have 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 $1,000.
For the land, the firm has to pay $1,000
and for the labor ... and for the labor, the firm also
has to pay $1,000 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 minus 3,000 gives us a profit of $500
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 $500 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 firms provide the households goods and services
and then the households are providing the firms,
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 at 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 at the end of the day,
the households are really giving the firms
the factors of production.
Factors ... Factors of production.
At an exchange for the factors of production,
the households in exchange for giving these things,
the firms 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 were an economist that were to observe this
and I guess if we're to focus 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 ... 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 counted all of that,
you would be essentially triple counting.
If you counted the total revenue, the total expenditures
and the total income, they are all about $3,500.
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 by using this firm as some type of vehicle.
He's consuming his own labor.
He's renting out a house from a firm
that he has rented his house to.
So it 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.