Macroeconomics

• The circular flow model is an economic model that presents how money, goods, and services move between sectors in an economic system.
• The circular flow of economic activity is a simplified macroeconomic model of the basic economic relationships in a market economy.
• The Circular Flow model represents the continuous flow of money among the sectors of the economy.
• circular flow model is The process of exchange results in economic activities like production, consumption, investment and expenditure.
• The circular flow model plays a significant role at the time of calculating national income.
• The circular flow model shows the cycle of economic activity between these sectors of the economy.
• The major sectors of the economy are: Domestic or Household, Corporate or Firms, Government, and Foreign or Rest of the world.
• There are certain leakages and injections in the economy which result in an increase or decrease in the national income.
• Leakages are the withdrawal of income in the economy such as savings, taxation, and imports.
• Injections are the introduction of income in the economy such as investment, government expenditure, and exports.
• Savings are considered a leakage
• Taxation is considered a leakage because taxes are collected by the Government and, if not spent, will generate no new output.
• Imports are considered a leakage
• Investment is an injection
• Government expenditure is injection
• Government spends money by giving subsidies, services and investments in construction projects.
• In the Three-sector Model, the government earns revenue in the form of taxes, from households and firms.
• The Four-sector model shows the flow of income in an open economy and consists of economic activities between the three sectors with the foreign sector/rest of the world.
• In the two-sector model with saving and investment, the equilibrium is obtained when S = I, where S is Savings and I is Investment.
• Four-Sector model The firm receives payment from the external sector for the exports, while the payment is made to the external sector for the imports.
• Savings of the government moves to the financial market and raises loan from the financial system.
• Imports and exports affect the national income in an open economy.
• In an open economy, imports and exports affect the national income.
• Transfer payments are made by the Government to the household sector and provide subsidies to the business sector.
• The importance of Circular Flow Model, is a measure of National Income, gives an idea about the injection or leakage in the flow of money, it shows the interdependence of economic sectors and their activities, represents the overall health of the economy, and helps to detect causes and remedies for the imbalance in the economy.
• Exports is considered as injection .
• The Three-sector Model includes government along with domestic and corporate sectors and plays a crucial role in maintaining balance in the economy.
• Government acts both as a producer and consumer for households and firms and receives money in the form of direct and indirect taxes.
• Factor services are provided by the household sector to the external or foreign sector, for which it receives net factor payments.
• Limitations of Circular Flow Model: Assumptions, Non-monetary Transactions, Dynamic Environment, Natural Disasters.
• There are two types of flow within the circular flow model: Real Flow and Money flow.
• Real Flow is the mobilization of resources and commodities in the economy, such as factors of production, goods, and services.
• Money flow depicts the movement of money between households and firms, such as factor payments and consumption expenditure.
• The two-sector model shows the circular flow of income in a simple economy, consisting of sectors: households and firms.
• Household or The domestic sector provides the factors of production to the firms like: Land, Labour, Capital, Enterprise.
• The firms use factors of production in the production of goods and services.
• The household spends its total income on the consumption of goods and services.
• Firms make factor payments like: Wages, Rent, Interest, Profits, etc.
• Assumptions of a two-sector model include: The firms recruit factors of production from the domestic sector, the households consume goods and services produced by firms, there are no savings and investments, there are no borrowings among the households, and there is no foreign trade.
• In the two-sector model with saving and investment, the household saves some amount from their income, but savings are the leakages from the economy, as discussed in the previous sections.