Circular-Flow-of-Income. Economics Presentation

Presentation

1. GURU GOBIND SINGH INDRAPRASTHA UNIVERSITY UNIVERSITY SCHOOL OF LAW AND LEGAL STUDIES Submitted by – Harsh Singh Course and year – B.A.L.L.B 2nd year Enrolment number- 07716503822 Submitted to – Dr. Anuradha Jha Circular Flow of Income Subject- Economy II

2. Circular Flow Of Income

3. What is Circular Flow of Income ?  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.  The circular flow illustrates the interdependence of the “flows,” or activities, that occur in the economy, such as the  production  of goods and services (or the “output” of the economy) and the income generated from that production. The circular flow also illustrates the equality between the income earned from production and the value of goods and services produced.  In the circular flow model, producer is referred to as firms and consumer are referred to as households .

4. Real Flow Real flow is when goods and services move from one sector of the economy to another sector. Real flow is named so because there is the  physical transfer  of goods and services amidst the two sectors, i.e.  households and firms . Hence, it is also termed as  product flow  or  physical flow . Therefore, real flow is in the form of: The household sector provides factors of production to the producer sector. The actual flow of final goods and services from producers (firms) to consumers (households).

5. Money Flow The money flow refers to the flow of factor payments from firms to households for factor services. Similarly, the flow of consumption expenditure from households to firms for the purchase of goods and services manufactured by the firms. I n a nutshell, Households represent consumers of goods and services, which also owns the factors of production. Firms represent the producer group, who produce the goods and services, and for this, they require inputs and so they hire factors of production from the household sector. Therefore, firstly money flows from firms to households in the form of factor payments for the factors of production provided by the household sector and then the money flows from households to the firms, in the form of consumption expenditure.

6. TWO SECTOR MODEL In the basic two-sector circular flow of income model, the economy consists of two  sectors : Households   firms The model assumes that there is no  financial sector , no  government sector , and no  foreign sector . In addition, the model assumes that: through their expenditures, households spend all of their  income  on  goods and services  or  consumption,  and through their  expenditures , households purchase all output produced by firms. This means that all household expenditures become income for firms. The firms then spend all of this income on  factors of production  such as labor, capital and raw materials, transferring all of their income to the households. The households, in turn spend all of their income on goods, which leads to a circular flow of income.

7. THREE SECTOR MODEL T he three-sector model includes- Households Firms government The government sector consists of the economic activities of local, state and federal governments. Flows from households and firms to government are in the form of taxes. The income the government receives flows to firms and households in the form of subsidies, transfers, and purchases of goods and services. Every payment has a corresponding receipt; that is, every flow of money has a corresponding flow of goods in the opposite direction. As a result, the aggregate expenditure of the economy is identical to its   aggregate income making a circular flow .

8. Four Sector Model The four-sector model adds the foreign sector to the three-sector model. The foreign sector is additionally called the "external sector," the "overseas sector," or the "rest of the world." Thus, the four-sector model includes (1) households (2) firms (3) Government (4) the rest of the world. It excludes the monetary sector. The foreign sector includes (a) foreign trade (imports and exports of products and services) and (b) flow and outflow of capital (foreign exchange). Again, every flow of cash incorporates a corresponding flow of products (or services) within the other way. each of the four sectors receives some payments from the other in place of products and services that makes a daily flow of products and physical services. The addition of the foreign sector transforms the model from a closed economy to an open economy.

9. Five Sector M odel T he five-sector model includes households Firms Government the rest of the world the financial sector

10. The five sector model of the circular flow of income is a more realistic representation of the economy. The first is the Financial Sector that consists of banks and non-bank intermediaries who engage in the borrowing (savings from households) and lending of money. In terms of the circular flow of income model the leakage that financial institutions provide in the economy is the option for households to save their money. This is a leakage because the saved money cannot be spent in the economy and thus is an idle asset that means not all output will be purchased. The injection that the financial sector provides into the economy is investment (I) into the business/firms sector. The leakage that the Government sector provides is through the collection of revenue through Taxes (T) that is provided by households and firms to the government. For this reason they are a leakage because it is a leakage out of the current income thus reducing the expenditure on current goods and services. The injection provided by the government sector is Government spending (G) that provides collective services and welfare payments to the community. An example of a tax collected by the government as a leakage is income tax and an injection into the economy can be when the government redistributes this income in the form of welfare payments that is a form of government spending back into the economy. The final sector in the circular flow of income model is the overseas sector which transforms the model from a closed economy to an open economy. The main leakage from this sector are imports (M), which represent spending by residents into the rest of the world. The main injection provided by this sector is the exports of goods and services which generate income for the exporters from overseas residents.

11. 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.

12. The State Of Equilibrium  In 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 If the state of the sum of total leakages does not equal the sum of total injections it will result in disequilibrium. Disequilibrium can be shown as: • Savings + Taxes + Imports ≠ Investment + Government Spending + Exports • S + T + M ≠ I + G + X

13. Therefore since the leakages are equal to the injections the economy is in a stable state of equilibrium. This state can be contrasted to the state of disequilibrium where unlike that of equilibrium the sum of total leakages does not equal the sum of total injections. By giving values to the leakages and injections the circular flow of income can be used to show the state of disequilibrium. Disequilibrium can be shown as: S+T+M≠I+G+X Therefore it can be shown as one of the below equations where: Total leakages > Total injections P150 (S) + P250 (T) + P150 (M) >P75 (I) + P200 (G) + 150 (X) Or Total Leakages < Total injections P50 (S) + P200 (T) + $125 (M) < P75 (I) + P200 (G) + P150 (X)