Companies who pay wages to workers and produce output. The blue line shows households spend their money on goods and services produced by firms. Although this version of the circular flow is simple, it teaches us four key insights that remain true albeit in slightly refined forms in more sophisticated versions as well. A leakage occurs in the income flow and an injection in the expenditure flow. Circular Income Flow with Saving and Investment : In our above analysis of the circular flow of income we have assumed that all income which the households receive, they spend it on consumer goods and services.
These flows are part of the fundamental process of satisfying human wants. For the firm, the total revenue. If government purchases exceed net taxes then the government will incur a deficit equal to the difference between the two, i. Businesses produce goods and services and in the process of doing so, incomes are generated for factors of production land, labour, capital and enterprise — for example wages and salaries going to people in work. From the circular flows that occur in the open economy the national income must be measured by aggregate expenditure that includes net exports, that is, X-M where X represents exports and M represents imports. Money that is used to pay foreign entities for goods and services through M also constitutes a.
Debt repayments are a form of saving because they, too, are income that is not devoted to consumption or taxes. These red lines are our leakages or withdrawals. Another is to look at how these policies affect aggregate demand and aggregate supply. In other words, in our above analysis we have not taken into account the role of foreign trade. The circular flow analysis is the basis of national accounts and hence of.
Total amount spent on goods and services. But in the long run, exports of an economy must balance its imports. . Everything here is on an annual basis. Things like public services, roads and buildings etc are all funded by the government. Business sector demands the factors of production from factor market. Households sell their factor services to firms in the factor markets and in exchange receive wages the left hand side of the flow.
Another method of financing Government expenditure is borrowing from the financial market. To measure the national product, we add up the value of all final goods and services produced in a country in a year. They must equal the dollars that flow out of the household sector—its spending. In other words, the households always buy all the goods and services the firms produce. In other words, saving is withdrawal of some money from the income flow.
The household sector, business sector and the government sector have already been defined in the previous sections. These terms are explained in detail in. In analysing the circular flow of income, there are three scenarios: 1. This is the case we have drawn in. Any extra money spent will be reflected by extra output that the firms make.
We may even make the extreme and artificial assumption that all prices are completely fixed. If the equality between planned savings and planned investment is disturbed by increase in savings, then the immediate effect will be that the stocks of goods lying in the shelves of the shops will increase as some of the goods will not be sold due to the fall in consumption i. Businesses that invest I money to purchase capital stocks contribute to the flow of income in the economy. There are no purchases of imports or exports. Owing to the deficiency of demand for goods and the accumulation of stocks, retailers will place small orders with the wholesalers. Link between Producers and Consumers: The circular flow establishes a link between producers and consumers.
Firms can use land from households to build factories to make products. The household sector receives income from business sector by providing the factors of production owned by it. Money coming from abroad to buy domestically produced goods. The linkage between the saving of households and the investment of firms is one of the most important ideas in macroeconomics. The business sector consists of producers who produce products and sell them to the household sector or consumers. Looking at some basic measurements of the economy has allowed you to be more concrete about the problems in Argentina.
It buys exports produced by the domestic economy and produces imports purchased by the domestic economy, which are commonly combined into net exports exports minus imports. So, let's now put it all together. The government deficit must be financed by borrowing in financial markets. Transfer payments are treated as negative tax payments. The government borrowing through its effect on the rate of interest affects the behaviour of firms and households. On the other hand, the business sector makes payments to the foreign sector for imports of capital goods, machinery, raw materials, consumer goods, and services from abroad.