Circular flow

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What is an economy?

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Circular flow

  1. 1. WHAT IS AN ECONOMY?• How to describe something as complex as an economy• As a Metaphor ? Eg, a bowl of spaghetti ? (Why?) each strand represents an economic transaction
  2. 2. As a machine ?
  3. 3. As a biological system
  4. 4. As a model• Economists thankfully have developed a simple model ( to represent the major areas of activity and flows of money between them) known as “The Circular Flow of Income”• FEATURES:• 5 major areas (or “Sectors” of activity)• Income/money flows between these sectors
  5. 5. CIRCULAR FLOW OF INCOME 2 Sector Model1. Household Sector comprises total population - who are consumers - and producers (owners of resources) - Households receive income for providing resources ( land, labour, capital,enterprise) to the business sector2. Business Sector – where all production occurs and sells goods and services
  6. 6. 2 Sector Model Income (Y)Household Business Consumption
  7. 7. 3 Sector Model3. Finance Sector – where people SAVE and BORROW money, eg, banks, building societies, credit unions, superannuation companies, sharemarket, etc. (Business borrowing is known as INVESTMENT)
  8. 8. 3 Sector ModelHousehold Business Finance Savings Investment
  9. 9. 4 Sector Model4. Government Sector – (Federal, state and local) where the Government TAXES people (and businesses) and SPENDS money (eg subsidies to businesses, welfare payments to households)
  10. 10. 4 Sector ModelHousehold Business Finance Savings Investment Govt. Tax Govt Spending
  11. 11. 5 Sector Model5. Overseas Sector – There are many flows of money in and out of Australia. The most well known flows are payments overseas (IMPORTS) and payments to Australians (EXPORTS) for goods.
  12. 12. 5 Sector ModelHousehold Business Finance Savings Investment Govt. Tax Govt Spending Overseas Imports Exports
  13. 13. Equilibrium: Leakages and InjectionsLeakages (Red Lines) are money that leaves the circular flow eg. – Savings – Tax – ImportsInjections (Green Lines) are money that enters the economy eg. – Investment – Govt. spending – Exports
  14. 14. 5 Sector Model Household Business Finance Savings InvestmentLeakages Injections Govt. Tax Govt Spending Overseas Imports Exports
  15. 15. Equilibrium: Leakages and InjectionsIf leakages are higher than injections Total Income (Y) will fallIf injections are higher than leakages Total Income (Y) will rise If leakages = injections Total Income (Y) will not change ie The Economy is in “EQUILIBRIUM”

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