Explain the circular flow of economy. Explain the circular flow of income in an open economy? 2022-12-22
Explain the circular flow of economy
The circular flow of economy is a model that represents the movement of goods, services, and money between producers and consumers in an economy. It is a visual representation of the way that economic activity occurs, and it helps to explain how different sectors of the economy are interconnected.
In the circular flow model, there are two main groups of economic actors: households and firms. Households are the consumers in the economy, and they earn income by selling their labor or other resources to firms. Firms, on the other hand, are the producers in the economy, and they use the resources and labor provided by households to produce goods and services that are sold to households and other firms.
The circular flow of economy can be divided into two main parts: the real economy and the financial economy. The real economy is the part of the economy where goods and services are produced and consumed, and it is characterized by the flow of goods, services, and resources between households and firms. The financial economy is the part of the economy where money is exchanged, and it is characterized by the flow of money between households and firms.
In the real economy, households provide firms with the resources and labor needed to produce goods and services. In return, firms pay households for their resources and labor, and this payment is known as income. Households then use their income to purchase goods and services from firms, and this creates demand for the goods and services that firms produce.
In the financial economy, firms use the money they receive from selling goods and services to pay for the resources and labor that they need to produce more goods and services. Households, on the other hand, use their income to purchase financial assets, such as stocks and bonds, which provide a return on investment in the form of dividends or interest.
Overall, the circular flow of economy is a continuous process in which households and firms interact to produce and consume goods and services, and in which money flows between them to facilitate the exchange of these goods and services. It is a key concept in economics that helps to explain how different parts of the economy are connected and how economic activity occurs.
The Circular Flow of Income and Expenditure
Business firms consider the interest rate as cost of borrowing and the rise in the interest rate as a result of borrowing by the Government lowers private investment. Sandeep Garg Macroeconomics Class 12 Solutions Circular flow of Income — Short Questions Q. It makes payments for import of goods and services from firms and the government. The other is the flow of goods and services from individuals to firms and back again: people go to work to produce things for daily consumption. This creates a never ending, interconnected network of individuals like Jonathan whom all depend on one another to keep the system going. In other words, we have expenditure- side transaction.
Circular Flow of Income and Expenditure
This money is then used for purchases, production of goods and services, and to create new business ventures. The four-sector circular flow model consists of individuals, businesses, the government, and overseas. In the first place, we assume that neither the households save from their incomes, nor the firms save from their profits. Goods, money, and services are the three major flows in the economy. However, the basic model of the circular flow of income considers only two sectors — the firms and the households — which is why it is called a two-sector economy model. Business sector makes use of these resources inputs in the production and in the process supplies final goods and services through product market Box III to households Box IV for the satisfaction of their wants—through money, being the chief medium of exchange. These are injections into the circular flow of money.
Circular Flow of Economic Activity: Meaning and Models
After working for six months, Bob decides to purchase a home. These days financial markets around the world have become well integrated. On the other hand, when the domestic households, firms or the government imports something from the foreign sector, leakage occurs in the circular flow model. These two cycles give an overview of how an economy works: if you want to pay for goods and services, you need to exchange money for them. In fact we have explained above the flow of money that occurs in the functioning of a closed economy with no savings and no role of government.
Circular Flow of Income: 2 Sector, 3 Sector and 4 Sector Economy
In the diagram, the sale of goods and services by firms to consumers in the product market is shown in the lower portion of the inner circle from left to right; and the sale of their services to firms by households or consumers in the factor market is shown in the upper portion of the inner circle from right to left. Households both receive money and spend money in the circular flow diagram. The Circular Flow in a Two-Sector Economy 3. For the circular flow of income to continue unabated, the withdrawal of money from the income stream by way of saving must equal injection of money by way of investment expenditure. At simplest level circular flow of money contains two elements such as income workers get money or money flows to workers in the form of wages or salaries and money flows back to the firm in exchange of They pay wages or salaries to hired labor which is called income. ADVERTISEMENTS: We see in the model that government expenditure is not equal to taxes and savings are no longer equal to intended investments but the macroeconomic equilibrium or the circular flow of the economy obtains nevertheless because total expenditure is equal to the value of total output. If the government receipts are greater than the expenses, the surplus goes to capital market.
What is Circular Flow In Economics? 3 Models of Circular Flow
But the government purchases the services of the households, makes transfer payments in the form of old age pensions, unemployment relief, sickness benefit, etc. In other words, in our above analysis we have not taken into account the role of foreign trade. The circular flow model in a four-sector open economy has been shown in Fig. Models of Circular Flow in Economics 1 Two Sector Model : In this model, two sectors of a simple economy are considered, one is the household sector and another is the business sector which includes firms. In a three-sector closed economy, the government intervenes.
Circular Flow of Income: Definition, Model & Types
Three Sector Model : The three sector model of a simple economy shows the circular flow of economic activity involving government transactions. Taxes in the form of personal income tax and commodity taxes paid by the household sector are outflows or leakages from the circular flow. Rate of interest, which is the price for the use of savings, is determined by saving and investment. Graphically, we can present the circular flow of income. Firms spend on investment in order to expand their productive capacity in future.
The government levies taxes worth Rs. On the other hand, the leakages are payments made to foreigners for the purchase of goods and services. They are also linked through the factor market where the factors of production are sold and bought. The circular flow of income in a four-sector economy is shown in Fig. ADVERTISEMENTS: However, should the business sector decide to buy the leftover output worth Rs. However, you've probably also noticed that there is an inner circle as well.
Sometimes those goods are groceries, while other times those goods are clothing for an important event. Recommended Articles This has guided the Circular Flow of Income and its definition. Answering the requirements should be good for revision from the content. As such, the role of government cannot be ignored in any economy because of such a huge control it possesses over the economic cycle. Firms make production decision.