The circular flow model of income is a theoretical representation of the economy that helps to understand the interactions between households and firms in an economy. It illustrates the flow of money and goods between these two groups, and how they are interconnected through the market.
In the circular flow model, households are the source of labor, capital, and entrepreneurship that firms need to produce goods and services. Firms, in turn, pay wages and profits to households in exchange for these inputs. This exchange of money for goods and services is represented by the flow of money from firms to households.
On the other hand, households use their income to purchase goods and services from firms. This flow of money from households to firms is called the flow of expenditure.
The circular flow model also illustrates the role of government and financial institutions in the economy. Government collects taxes from households and firms, and uses this money to provide public goods and services, such as education and defense. Financial institutions, such as banks, facilitate the flow of money between households and firms by providing loans and other financial services.
There are two main types of markets in the circular flow model: the goods and services market and the factor market. The goods and services market is where firms sell the goods and services they produce to households and other firms. The factor market is where households and firms exchange the factors of production, such as labor and capital.
Overall, the circular flow model helps to understand the fundamental economic principles of how households and firms interact in the market and the role of government and financial institutions in the economy. It is a useful tool for policymakers and economists to analyze the impacts of economic policies on the overall economy and make informed decisions.
Circular Flow Model
Therefore, the circular flow in a four-sector economy consists of households, firms, government, and the foreign sector. An amount of money is injected into the flow when individuals or businesses borrow. Do all individuals within households act in exactly the same way? We further assume that the government does not play any part in the national economy. Besides the flows of circular income in the two-sector economy with a financial market, the additional flows due to the inclusion of the Government are: 1. Answer Basis Real Flow Money Flow a Meaning It is the flow of factor services from households to firms, and the flow of goods and services from firms to households. Besides, the firms also borrow money from outside to finance their expansion plans. Involvement of the foreign sector also involves foreign investments.
Circular Flow of Income: Definition, Model & Types
However, there is a subtle distinction between GNP and GDP since both move closely together. However, it does not happen in the actual world, i. On the contrary, if investment expenditure is greater than savings, rate of interest will rise so that at a higher rate of interest savings increase and become equal to planned investment expenditure. Firms spend money for buying input services. It shows how money circulates between different sectors and how households and business firms interact with each other. Companies then spend all their earnings on labour, capital, and raw materials, thereby transferring them back to individuals. Leakage happens when individuals save money that does not pass through the regular flow—for example, savings, imports, and taxes.
Circular Flow of Income: Types and Descriptions
The circular flow model in a four-sector open economy has been shown in Fig. He possesses over a decade of experience in the Nuclear and National Defense sectors resolving issues on platforms as varied as stealth bombers to UAVs. When households save, their expenditure on goods and services will decline to that extent and as a result money flow to the busiÂness firms will contract. 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. As a result, circular flow of income does not continue at a steady level in a free-enterprise capitalÂist economy unless certain corrective and preventive steps are taken by the government to maintain stability in the economy. What are the Methods of Calculating National Income? We appreciate your feedback! It also factors in income through rent, salaries, interest, wages and profits.
Circular Flow of Income and Methods of Calculating National Income
Payments are received by the respective sectors in exchange for goods, resources, and services. Example: Flow of water in a river, income earned in a year, etc. An open economy consists of households, firms, the government, and the rest of the world. Individuals are also called households or the public, while firms are businesses or the productive sector. That is, each flow of money has an equal and opposite flow of commodities. Circular Income Flow in a Three Sector Economy with Government : In our above analysis of money flow, we have ignored the existence of government for the sake of making our circular flow model simple.
Circular Flow of Income: 2 Sector, 3 Sector and 4 Sector Economy
Say, Where will the savings flow? On the other hand if value of imports exceeds value of exports of a country, trade deficit occurs. The flow of money differs in volume as per the economic cycles. These sectors, on the whole, account for GDP expenditures. Thus Government borrowing reduces private investment in the economy. In such a setup, the households serve as a source of factors, and they generate income by providing factor services to business firms. It involves the exchange of money. Goods, money, and services are the three major flows in the economy.
