Circular Flow of Income.pdf

8/10/2019 Circular Flow of Income.pdf

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The Economy as a Circular Flow

of Income and Expenditure

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The Circular Flow of Income and Expenditure

In an economy millions of people are buying, selling, working, hiring.

Since economy as an integrated system ofproduction, exchange and

consumption, it has two types of decision makers

1. Producers(Seller): who produces goods and services and sale in

the market , receives income

2. Consumer ( Buyer): who spends money in exchange for goods

and services bought , made expenditure

Buy and sell goods and services

Production flow ( Income)

Money Flow ( Expenditure)

So total income = total expenditure at a point of time


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The Circular Flow of Income and Expenditure

Economic Agents

1. Individual/Households/Society

2. Firms/Industry

3. Government

4. External Sector

So we have circular flow of Income and Expenditure for

1. One Sector

2. Two Sector

3. Three Sector

4. Four Sector

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The Circular Flow of Income and Expenditure:One Sector Model

Households in the only one sector

Ex, Robinson Crusoe , who lived an island

Whatever it produces, it consumes

So his aggregate supply AS=Y=f (N)

His aggregate demand AD=C

Equilibrium: AD= AS

=>Y=C


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The Circular Flow of Income and Expenditure:

Two Sector Model

Two Sector:

1. Households:

1. Owner of all factors of productions: La, L, K, O

2. Total income= R+w+i+p

3. Consumes goods and services

4. Made Expenditure on goods and services

2. Firms/Industry:

1. They own no resources of their own

2. Hire and use factors of production: La, L, K, O

3. Make Factor Payments

4. Produces and sell goods and services to households

5. No saving

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The Circular Flow of Income and Expenditure:Two Sector Model

Assumptions:

Only two sectors Consumers(Household) and

Producers(Firms)

All production is sold to the consumers

Producers provide all the Goods and Services, no

inventory. Make factor payment R, w, i and p

Consumers spend all their Income on goods an

services. No Savings. Consumers are the owners of

productive resource - land, labour, capital andenterprise

No government and no overseas sectors

No inflow or outflow of income or goods and services

outside or inside.


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Two Sector Model

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The Circular Flow of Income and Expenditure:Two Sector Model

Important Identities:

Household Income (Y) Y=FP

Firms Factor Payment (FP) FP= R+w+i+p

Identity: Y R+w+i+p

Household Expenditure:(E) E=Y

Firms Supply of goods and services (Z) Y=V

Identity: YV

Means

Households income (Y) Factor Payments (FP) Money Value ofGoods and Services (V)

So

Y FP V


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Two Sector Model

(With Savings and Investment)

Withdrawals and Injections:

Withdrawals: An amount that is set aside by thehouseholds and firms and is not spent ondomestically produced goods and services over a periodof time

Ex. Savings is an withdrawals

Injections: An Injections is the amount that is spent by

households and firms in addition to thatincome generated within a regulatedeconomy.

Ex. Own hoarding or borrowing and spending

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Two Sector Model(With Savings and Investment)

Flow of Money

Flow of Goods and Service

All saving are made by households and entered to the firm through financial

markets, So, S=I


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Three Sector Model

Three Sector:

1. Households

2. Firms/Industry

3. Government

1. Revenue: Direct taxes

2. Expenditure: Govt. spending on goods and services

3. Transfer payment: pension, unemployment benefit

If G=T balanced budget

If G>T deficit budget

If G


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Three Sector Model

Withdrawals

Taxes are withdrawals as they reduces thepvt disposable income of the households

Injections

Govt Exp are injections as they add totheir income

Transfer payment are also injections asthey add income

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The Circular Flow of Income and Expenditure:Four Sector Model

1. Households:

C

2. Firms/Industry

I

3. Government

Revenue: Direct taxes (T)

Expenditure: Govt. spending on goods and services (G)

Transfer payment (tr)

4. External Sector

Import (M)

Export(X)


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Four Sector Model

Assumptions:

The external sector consists of only exports(X) and

imports)

The export of goods and services and non-labour

services are only made by firms

Households only exports labor

If X>M net gain from trade

IfX


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Four Sector Model

Withdrawals

Imports are withdrawals as theyreduces the income of the households

Injections

Exports are injections as they add totheir income

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Thank You All


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Circular flow of Income and Expenditure:

Two Sector Model

FirmsHouseholds

Market for

Factors

of Production

(Factor Flow)

Market for

Goods

and Services

(Goods Flow)

SpendingRevenue

Factor payment=Rent,wages, interest and

profit

Factor Income

Goods & Servicessold

Goods & Servicesbought

Land, Labor, Capital

and Entrepreneur

Inputs for production

Circular flow of Income and Expenditure:

Two Sector Model

FirmsHouseholds

Market for

Factors

of Production

(Factor Flow)

Market for

Goods

and Services

(Goods Flow)

SpendingRevenue

Rent, wages,interest and profit

Income

Goods & Servicessold

Goods & Servicesbought

Land, Labor,Capital and

Entrepreneur

Inputs forproduction

Capital MarketInvestment Savings


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FirmsHouseholds

Market for Factors of Production(Factor Flow)

Market for Goods and Services

(Goods Flow)

SpendingRevenue

Rent, wages, interest and

profit Income

Goods & Services sold Goods & Services bought

Land, Labor, Capital andEntrepreneur

Inputs for production

Capital Market

Investment Savings

Government Direct TaxesDirect and indirect Taxes

Govt Purchse and Subsidies Wages, Salaries and transfer Payment

Foreign Sector

Receipts from exports Foreign Remittance

Export of man powerPayments for imports

Documents

Circular Flow of Income.pdf