Circular Flow

• Money flows refers to the movement of income and spending between households and firms.
• Real flows refer to the movement of goods, services and resources between households and firms.
• Microeconomics


  Studies the behaviour of individual households and firms
• Macroeconomics


  The branch of economics that studies the behaviour and performance of an economy as a whole, focusing on large-scale economic factors and overall economic activity
• Circular Flow of Income Model


  Macroeconomic model that describes the flows of resources, goods and services, income and expenditure between different parts of the economy
• Households


  The owners of the factors of production and the buyers, and receive income in return
• Firms


  The employers of resources, produce all the goods and services of the economy, and receive revenue from households
• Financial Sector


  Facilitates savings and investments through banks and financial institutions
• Government Sector


  Collects taxes and redistributes income through government spending
• Overseas Sector


  Involves trade with other countries, including exports and imports
• Real Flow


  The flow of goods, services and resources
• Money Flow


  The flow of spending and income
• Factor Market


  All of the resources that businesses use to purchase, rent, or hire what they need in order to produce goods or services, i.e. Factors of production / resources from households in exchange for income
• Product Market


  Goods and services are bought and sold, i.e. Goods and services produced by firms are sold to households for expenditure
• Savings (S)


  The portion of household income not spent on goods and services for current consumption. Households deposit their surplus funds into financial institutes such as banks or superannuation funds.
• Leakage


  Money is taken out of the economy/ Reducing amount of money/income circulating in the economy.
• Investment (I)


  The expenditure of goods and services which are not intended for current consumption. E.g. Purchase of capital equipment to be used in production. Leads to increased production of final goods and services for future consumers, therefore creating an increase in the flow of income in the future
• Injection


  Money is injected into the economy, increasing money flow in the economy. Offsets the savings leakage.
• Taxation (T)


  Households pay some of their income to the government
• Leakage


  Taxes are taken out of gross income, decreases disposable income to spend on goods/services in the economy.
• Government Expenditure (G)


  Collective goods and services communities need are provided through government expenditure.
• Injection


  Injects the taxation leakage back into the economy, increasing amount of money flowing.
• Imports (M)


  Money flows from Australia to overseas in exchange for goods, services or resources.
• Leakage


  Circular flow of INCOME. Receive goods into the country/economy, but the income/money leaves our economy.
• Exports (X)


  Money flows from overseas to Australia in exchange for goods, services or resources.
• Injection


  Send goods and services overseas, get an injection of money in return.
• 2-sector model assumptions:

  • Households own all the resources and are buyer
  • Firms are the employers of the resources and produce goods and services
  • Factor market - exchange of resources for income
  • Exchange of goods and services
  • 2 markets are interdepended
• 5-sector model assumptions:

  • A capital market (financial sector) exits to match the needs of households with surplus income and the firms that wish to borrow for investment
  • The government provides many community needs, financed by taxation
  • Trade with other countries provides for the needs we cannot produce ourselves in return for goods and services that are surplus to our needs.
• The relationship between them

  Total spending in an economy determines the total output and total income
• Total spending (Consumption Expenditure)


  The total amount of money spent on goods and services in an economy. It includes consumption by households, investment by businesses, government spending, and net exports (exports minus imports)
• Total output (All goods & services)


  The total value of goods and services produced in an economy
• Total income (Y)


  The total earnings from production, which includes wages, rent, interest, and profit
• Macroeconomic equilibrium


  The state where total spending equals total output, meaning there is no tendency for the economy to change its level of output or income. Will always return to an equilibrium
• Macroeconomic equilibrium


  1. When the rate of/ sum of all leakages is equal to the rate of/ sum of all injections

  2. S+T+M=I+G+X

  3. Sum of all output (O) = sum of all Expenditure (E) = sum of all income (Y)

  4. All income is spent and all output is consumed
• Leakages


  Outflow of money from the circular flow of income. The state where total spending equals total output, meaning there is no tendency for the economy to change its level of output or income.
• Increase in leakages


  The level of economic activity will decrease, potentially leading to unemployment and lower output
• Higher Savings (S)


  • More savings mean less consumption spending by households
  • Firms experience reduced demand for their products, leading to lower production and potentially lower income and employment levels
  • If savings are not matched by an equal increase in investments, the economy's overall activity decreases
• Higher Taxes (T)


  • Higher taxes reduce disposable income for households and firms, leading to lower consumption and investment
  • Government may use the tax revenue for spending (an injection), but if the tax increase is not fully matched by increased government spending, it can reduce overall economic activity
• Higher Imports (M)


  • Spending on foreign goods and services means less money spent on domestic products
  • This can reduce domestic firms' revenues, leading to lower production, income, and employment
  • If the increase in imports is not balanced by an increase in exports, it leads to a net leakage from the economy
• Injections


  Inflow of money into the circular flow of income. Money that enters the circular flow, increasing economic activity. Examples include investment, government spending, and exports.