Circular flow of Income

PPT ON CIRCULAR FLOW OF INCOME(Economics)

1. CIRCULAR FLOW OF INCOME Abhinav Singh Aman Singh Ishu Mor Gautam Sharma

2. Introduction The term circular flow of income or circular flow of economic activity refers to a simple economic model which describes the circulation/flow of income between producers and consumers. In the circular flow model, producer is referred to as firms and consumer are referred to as households.  The major exchanges are represented as flows of money, goods and services, etc.

3. Determinants Household Firm Financial institutions Foreign sector Government

4. Household It is a person or group of people that share their income. Require goods and services to satisfy their personal wants. Owns all resources ( i.e. labor, capital, land enterprise) The members of households have two functions. They supply different factors of production. Members of household also work as consumers.

5. Firms An organization that produces goods and services for sale. Main objective is to maximize profit in the production process Uses resources provided by households to products goods and services Sells those good and services for income The two main functions are as follows: Produce goods and series and supply them in the market Firms purchase inputs or raw materials from households to use them in the production process.

6. Government Just like households and firms the government also earns incomes and makes expenses. Two major functions are: Government earns revenue from either tax or non tax sources both from households and firms. Government provides essential public services such as maintenance of law and order, defense services, judiciary etc.

7. Financial institutions Consists of banks and non-bank intermediaries who engage in the borrowing (savings from households) and lending of money The leakage that financial institutions provide in the economy is the option for households to save their money.

8. Foreign sector It consists of two kinds of international economic transactions i.e. Export and import of goods and services Inflow and outflow of capital.

9. MODELS

10. Two sector model In the basic circular flow of income, or two sector circular flow of income model, the state of equilibrium is defined as a situation in which there is no tendency for the levels of income (Y), expenditure (E) and output (O) to change, that is: Y = E = O This means that the expenditure of buyers (households) becomes income for sellers (firms). The firms then spend this income on factors of production such as labour , capital and raw materials, "transferring" their income to the factor owners. The factor owners spend this income on goods which leads to a circular flow of income.

11. Three sector model I t includes household sector, producing sector and government sector. Here flows from household sector and producing sector to government sector are in the form of taxes . The income received from the government sector flows to producing and household sector in the form of payments for government purchases of goods and services as well as payment of subsidies and transfer payments .

12. Four sector model A modern monetary economy comprises a network of four sector economy these are: Household sector Firms or Producing sector Government sector Financial sector. Each of the above sectors receives some payments from the other in lieu of goods and services which makes a regular flow of goods and physical services. Money facilitates such an exchange smoothly. Financial institutions role it is to accept and protect the savings of consumers and to make investment funds available to producers.

13. Five sector model In the five sector model the economy is divided into five sectors : Household sector Firms or Producing sector Financial sector  : Government sector  Rest of the world sector: transforms the model from a closed economy to an open economy.

14. LEAKAGE AND INJECTION

15. LEAKAGE INJECTION SAVINGS (S) INVESTMENTS (I) TAXES (T) GOVERNMENT SPENDING (G) IMPORTS (M) EXPORTS (E)

16. Leakage Injection

17. Leakage means withdrawal from the flow. When households and firms save part of their incomes it constitutes leakage. They may be in form of savings, tax payments, and  imports. Leakages reduce the flow of income. Injection means introduction of income into the flow. When households and firms borrow the savings, they constitute injections. Injections increase the flow of income. Injections can take the forms of investment, government spending and  exports .

18. The state of equilibrium I n terms of the five sector circular flow of income model the state of equilibrium occurs when the total leakages are equal to the total injections that occur in the economy. This can be shown as : Savings + Taxes + Imports = Investment + Government Spending + Exports S + T + M ≠ I + G + X

19. If the state of the sum of total leakages does not equal the sum of total injections it will result in d isequilibrium . Disequilibrium can be shown as: Savings + Taxes + Imports ≠ Investment + Government Spending + Exports S + T + M ≠ I + G + X

20. Significance Measurement of national income - National income is an estimation of aggregation of any of economic activity of the circular flow. It is either the income of all the factors of production or the expenditure of various sectors of economy. Knowledge of interdependence - Circular flow of income signifies the interdependence of each of activity upon one another. If there is no consumption, there will be no demand and expenditure which in fact restricts the amount of production and income. Unending nature of e conomic activities - It signifies that production, income and expenditure are of unending nature, therefore, economic activities in an economy can never come to a halt. National income is also bound to rise in future. Injections and Leakages