Part 1 · Getting familiar with the economy · Lesson 2
The economy is a big circle of money
One person's spending is another person's income. Let's follow the path money takes among households, businesses, the government and the rest of the world.
QToday's question
Where does the KRW 5,000 you paid for a cup of coffee go next?
The moment you pay at the cafe, the money doesn't disappear; it passes to the next person. Follow that money all the way and you realize the whole economy is linked in one big circle. And somewhere on that circle stands the company whose stock you bought.
MAPLearning map for this lesson
We build it up in three steps. At the end of each step, a 'Quick check' lets you test your understanding before moving on.
In Lesson 1 you learned that a stock price ultimately comes from a company's earnings (stock price = EPS × PER). This lesson follows where those earnings come from, that is, whose wallet a company's revenue comes out of. If you haven't seen Lesson 1 yet, feel free to read Lesson 1, “Know the economy and stock prices make sense,” first.
- STEP 1 · Basic conceptsThe two wheels money rides on
You can draw the basic circular flow in which households and businesses exchange money and goods, and explain “spending = someone's income.”
- STEP 2 · Understanding the mechanicsThe big circle with the government and the rest of the world
You can tell the roles of the four economic agents apart, and explain how KRW 5,000 of coffee money is divided among several agents and the chain reaction that occurs when spending falls.
- STEP 3 · Real-world applicationKorea's circular flow and your stocks
You can see in the data why Korea is especially sensitive to overseas demand, and connect which path of the circular flow a news item touches to the sectors.
STEP 1The two wheels that keep money moving
Let's start by drawing the simplest possible economy. There are just two characters: people who work and spend, and companies that make things.
The two leads of the economy: households and businesses
In economics, the people or organizations that take part in economic activity are called . The two most basic agents are households, meaning individuals and families like us, and businesses, which make and sell goods and services.
The two agents exchange things each needs from the other. Households supply labor to businesses, and businesses pay wages in return. Households use those wages to buy what businesses make, and businesses receive that money as revenue. Labor and goods flow in one direction, and money flows in the opposite direction. This non-stop, interlocking motion is called the .
One person's spending is another person's income
The most important sentence in this picture is this: the money I spend does not vanish; it always ends up in someone's hands. When I buy bread, it becomes the bakery's revenue, and the bakery uses that revenue to pay the baker. The baker uses that wage to buy clothes, and the clothing store in turn pays its employees. It is a chain in which one person's becomes another person's income.
Let's connect this to what you learned in Lesson 1. A stock price comes from a company's earnings, and earnings are minus costs. But that revenue is ultimately someone's spending. So "how much are people spending?" is directly tied to company earnings and, in turn, to stock prices.
An easy analogy · Coins at an amusement park
Imagine coins that can only be used inside an amusement park. A visitor uses a coin to ride the bumper cars, the bumper-car attendant takes the coin, and on a break the attendant uses it to buy a hot dog. The hot-dog stand uses the coins it received to buy sausages. The number of coins stays the same, but the faster they pass from hand to hand, the livelier business inside the park becomes.
Now what if everyone puts their coins in their pockets and stops spending? Both the bumper cars and the hot-dog stand lose their customers. The economy works the same way. How much money there is matters, but how actively it circulates matters just as much.
Quick checkOffice worker A bought a phone with their salary. What two names does this money carry at the same time in the circular flow?
STEP 2The bigger circle with government and the rest of the world
Let's add two more characters to the two wheels of STEP 1: the government, which collects and spends taxes, and the rest of the world beyond our borders.
The third lead: the government
The government collects taxes from households and businesses, and uses that money to build roads, run schools and hospitals, and buy defense equipment. When the government hires a construction company to build a road, that money becomes the company's revenue and the wages of the site workers. The government is also an agent that receives money and sends it back out within the circular flow. When the economy weakens and households and businesses close their wallets, the government can deliberately increase spending to support the flow. This is commonly called economic stimulus.
The fourth lead: the rest of the world
When foreign companies and consumers buy semiconductors and cars made by Korean companies, foreign money flows in as revenue for those Korean companies. This is . Conversely, when we buy crude oil or foreign-brand products, Korean money flows out to the rest of the world. These are imports. The rest of the world is an agent that sits outside Korea's circle, both putting money in and taking money out.
See it in a diagram: the money paths linking the four agents
Press the buttons below to add the agents one by one. The moving dots show the direction money flows. Goods, services and labor generally flow in the opposite direction to money.
This is a simplified picture to explain the concept. In reality, businesses also pay taxes, households also receive money from the government such as pensions and welfare benefits, and savings flow through financial institutions into business investment.
Where a KRW 5,000 cup of coffee goes
Now let's return to the opening question. You paid KRW 5,000 for a cup of coffee at a neighborhood cafe. Tap each slice of the bar. Each slice shows which agent in the circular flow this money goes to.
Where the KRW 5,000 for one cup of coffee goes (a hypothetical neighborhood cafe)
The value-added tax is an actual calculation (10% included in the price → 5,000 × 10/110 ≈ KRW 455); the other proportions are hypothetical examples to aid understanding. Actual cost structures vary widely from cafe to cafe.
The KRW 5,000 did not stay in one place. It scattered to the employee's wages (households), the bean importer and overseas coffee farms (businesses and the rest of the world), the building owner's rental income (households), the cafe owner's profit (businesses), and value-added tax (government). Then each recipient spends their money somewhere else too. This spreading of one act of spending into many streams of income is the heart of the circular flow.
The chain reaction when spending falls
The circular flow can grow on its own in a good direction or a bad one. If people get anxious and cut spending all at once, the following chain reaction can occur.
Conversely, when exports increase and companies start building factories, a virtuous cycle arises in which revenue → employment → income → consumption rise in turn. The "four seasons of the economy" you will learn in Lesson 5 is this chain growing and shrinking. The money companies spend on factories and equipment is called , and it is also an important form of spending that becomes revenue for equipment makers and construction companies.
Where do savings go? The bridge called financial markets
Households don't spend all the money they earn. Some is saved in deposits, stocks and bonds. So does saved money leave the circular flow? No. Money deposited at a bank is lent to businesses, and money used to buy stocks is spent on factories and R&D when a company issues new shares. Savings cross the bridge of the financial markets and re-enter the flow as business investment.
This is where the stock investor's seat becomes visible. Buying a stock means buying a piece of a company that earns money on this big circle (Lesson 1). If that company stands on a thick road in the flow, its revenue and earnings grow; if the road thins, its earnings shrink. And how much money circulates in financial markets, and how cheaply, is set by interest rates, which move the multiple dial you saw in Lesson 1. Interest rates are covered in detail in Part 3.
How the circular flow leads to stock prices
Someone's spending → a company's revenue → earnings left after costs → earnings per share (EPS) → stock price. The more active the circular flow, the thicker the first link in this chain.
Common misconceptions
- "If everyone spends less, does the economy get stronger?"
- That's true for a single household, but if everyone cuts spending at the same time, other people's incomes fall and everyone can end up poorer. This is called the 'paradox of thrift'. Of course, since savings flow through financial institutions into business investment, saving is also essential in the long run.
- "Imports are always bad because money leaves the country?"
- No. Korea imports most of its crude oil and raw materials, uses them to make semiconductors, cars and petroleum products, and exports those. If imports are blocked, exports stop too. What matters is how actively the whole circular flow keeps turning.
Quick checkThe government decided to spend KRW 1 trillion on road construction. Whose income does this money become in the circular flow, and what happens next?
STEP 3Korea's circular flow and my stocks
Now let's compare the circular flows of real countries. Even with the same circle, which roads are thick differs from country to country.
Korea, where the overseas road is unusually thick
The total value a country newly creates in one year is called (covered in detail in Lesson 4). Comparing exports to GDP shows how thick the overseas road is in that country's circular flow.
Korea's exports are about 41% of GDP, nearly four times the US figure (about 11%). The US economy has a thick inner road of household consumption, while Korea has a thick outer road to the rest of the world. That is why the revenue and earnings of Korean companies swing heavily with overseas conditions, especially US and Chinese demand and the semiconductor cycle. In fact, semiconductors accounted for about 20% of Korea's total exports in 2024. This is why Korean investors watch the export and import figures released on the 1st of every month (covered again in Lesson 26).
For stocks: sectors standing on the money's path
In Lesson 1 you learned that a stock price moves with the earnings dial and the multiple dial. Depending on which road of the circular flow gets thicker, the earnings dial of the sectors standing on that road moves first.
These are sectors whose revenue comes out of individuals' wallets, such as retail, food, cosmetics, travel and leisure, and domestic auto sales. They gain strength when wages and employment rise.
These are sectors that earn revenue when other companies buy factories and equipment, such as semiconductor equipment, machinery, power equipment and plant construction.
These are infrastructure sectors such as road and housing construction, defense and power grids. They are heavily influenced by government budgets and policy announcements.
These are sectors whose revenue comes from overseas customers, such as exports of semiconductors, cars, ships and cosmetics. This is the road with the largest weight in the Korean stock market.
| News headline (example) | Road that thickened/thinned | Who is affected first |
|---|---|---|
| "September semiconductor exports hit an all-time high" | Overseas ↑ | Revenue expectations rise for semiconductor makers and their parts and equipment suppliers. |
| "Consumer sentiment weakens, retail sales decline" | Households ↓ | Earnings may fall in consumption-dependent sectors such as retail, dining and travel. |
| "Government announces expanded investment in power grids" | Government ↑ | Order expectations rise for power equipment and construction sectors. |
| "Large companies postpone plans to expand factories" | Business investment ↓ | Workloads may shrink in the equipment, machinery and construction sectors. |
These are hypothetical headlines to aid understanding. They are not a recommendation to buy or sell any particular stock.
It is not always this simple. When one road gets thicker, another can get thinner. For example, if import prices of raw materials rise sharply, more money flows overseas and domestic companies' costs go up. And if the news was already expected by the market, the stock price may barely move (covered in Lesson 20).
Quick checkThere's news that US consumers have started closing their wallets. Does that have nothing to do with the Korean stock market?
✓What we learned today
- The economy is a big circular flow in which four agents, households, businesses, government and the rest of the world, exchange money and goods and services.
- One person's spending is another person's income. The money I spend becomes a company's revenue, and that revenue is split again into wages, taxes and raw-material costs, becoming other people's income.
- If spending falls all at once, income falls, and when income falls, spending falls again in a chain reaction. This is a typical path by which business conditions worsen.
- Korea's exports are about 41% of GDP (2023), far larger than the US (about 11%). This is why overseas demand shakes the revenue and earnings of Korean companies so much.
- When you read the news, first ask yourself, "Which road of the circular flow got thicker or thinner?" The earnings dial of the sectors standing on that road is what moves.
Prices are set as money circulates. In the next lesson, you'll learn how that price is determined, through the two forces of supply and demand, using the memory semiconductor market as an example.
Quiz5-question quiz
Pick an answer and it's graded right away with an explanation.
Q1. In the circular flow, what is 'someone's spending' when seen from the other side?
The money I spend always ends up in someone's hands. My spending becomes a store's revenue, and that revenue becomes other people's income again, such as wages, rent and taxes.
Q2. Which of the following is not one of the four agents of the circular flow?
The four agents are households, businesses, government and the rest of the world. A stock exchange is a market where stocks are bought and sold, not a category used to classify economic agents.
Q3. What is likely to happen if everyone sharply cuts spending at the same time?
Since spending = someone's income, if everyone cuts spending together, revenue → employment → income fall in turn. This is called the 'paradox of thrift'.
Q4. In 2023, exports were about 41% of GDP in Korea and about 11% in the US. What hint does this give a stock investor?
Korea's economy has a thick outer road to the rest of the world. So overseas changes, such as US and Chinese demand or the semiconductor cycle, reach Korean companies' revenue and earnings quickly.
Q5. Which road of the circular flow does the news 'Government announces large-scale power grid investment' thicken first?
When the government spends money, it becomes revenue for power equipment and construction companies, and then spreads out as workers' wages. The 'earnings dial' you learned in Lesson 1 can move first in these sectors.
NextTerms · Next lesson · Related tools
People or organizations that engage in economic activity. They are usually divided into four: households, businesses, government and the rest of the world.
Circular flowCircular flowThe continuous flow in which economic agents exchange money, goods, services and labor in opposite directions. Someone's spending becomes someone else's income.
ConsumptionConsumptionMoney households spend to buy goods and services. From a company's point of view, it becomes revenue.
Capital expenditureCapital expenditureMoney a company spends to buy production assets such as factories, machinery and equipment. It becomes revenue for equipment and construction companies and increases future production capacity.
ExportsExportsSelling goods and services made at home to other countries. Money from abroad comes in as sales for domestic companies. Korea is a country with a large export share, about 41% of GDP (2023).
RevenueRevenueThe total amount a company earns by selling goods and services. It is the amount before deducting costs.
EarningsEarningsThe money a company has left after subtracting cost of sales, expenses, interest and taxes from revenue (net income). It is the most basic factor that determines the stock price.
GDPGross Domestic ProductThe total value of the goods and services newly produced within a country over a given period.
Business conditionsBusiness conditionsA term describing whether economic activity is lively or subdued. When business conditions are good, company revenue and earnings tend to grow.
SectorSectorA group of companies in similar businesses, divided into categories such as semiconductors, banks and autos.
This is educational material and not investment solicitation. There is no guarantee that past relationships will repeat in the future.