The three sector model shows the circular flow of income and expenditure between households, firms, and the government. Households receive income from firms and purchase goods and services. Firms produce goods/services and purchase inputs from households. The government collects taxes from households and firms, and spends on goods/services. Leakages like savings and taxes reduce household/firm income, while injections like investment and government spending add income into the circular flow. The economy is stable if injections equal leakages, contracting if leakages exceed injections, and expanding if injections exceed leakages. The government can impact the economy through taxing and spending policies.

1. Prepared by: N. JYOTI THREE SECTOR MODEL CIRCULAR FLOW OF INCOME & EXPENDITURE WITH GOVERNMENT

2. The Circular-Flow Diagram The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle

3. Circular-Flow of Economic Activities A household is a person or a group of people that share their income. A firm is an organization that produces goods and services for sale. Firms sell goods and services that they produce to households in markets for goods and services . Firms buy the resources they need to produce— factors of production —in factor markets .

4. The Government Sector Government taxation ( T) reduces households’ disposable income and business funds Government spending ( G) includes expenditure on collective goods and services and goods and services provided by the business sector, plus transfer payments

5. Three Sector Model

6. Leakages and Injections Leakages in the circular flow: Flows out of circular flow when resource income is received and not spend directly on purchases from domestic firms Savings(S) Taxes(T) Injections in the circular flow: Added spending in circular flow that does not come out of current resource income Investment(I) Government spending(G)

7. Savings and Investment If planned (I+G) = planned (S+T) so that injections = leakages and total spending = total income and demand = supply then we have a stable economy

8. Contracting Economy If leakages are Higher than injections ( Planned S+T > Planned I+G ) , economy contracts resulting in inventory accumulation too little spending drop in prices

9. Expanding Economy If injections are Higher than leakages (Planned I+G > Planned S+T) , economy expands resulting in more goods and services produced higher prices

10. Government and the Circular Flow Balanced budget: amount spent by government (G)= amount collected in taxes(T) Surplus budget amount spent by government (G)< amount collected in taxes(T) Deficit budget amount spent by government (G)> amount collected in taxes (T)

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