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Circular flow

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  • 1. Measurement & Structure of National Economy• A simplified version of economy consists of the following sectors_House hold sector-all individuals & families_Business sector-all variety of firms producing goods & services._Government sector- all services provided by govt. _External sectoral transactions with rest of the world.
  • 2. Assumptions(a)All production in business & govt. sector(b)Firms in business sector owned by house hold sector and govt. sector(c)All transactions between the two channeled through business sector except PT to FS
  • 3. • Following transactions take place between various sector of economy_Sale of goods & by BS to HHS, GS, ES_Supply of services by GS to HH sand BS_Purchase of goods & services from ES by BS_Sale of primary factor services by HHS to BS, GS, ES. These consist of labour (wages), provision of capital (interest), entrepreneurship(profit)land & buildings (rent)
  • 4. Circular Flow of Economic Activities• The economic activity remains in action only because of the operation of circular flow of money and goods.• The circular flows can be of two types: (1) Real circular flows which show the flow of goods or factor services from one sector to another. (2) The monetary circular flows which show the flows of money and income from one sector to another.
  • 5. • This circular flow brings out an important implication that money is capable of measuring the income many times more than the amount of money in circulation.
  • 6. • These flows and counter flows of money, goods and factor services keep the system in a state of continuous operation. This also highlights the basic identity i.e. value of final goods is equal to the total factor income received by the household sector. The circular flow in a two sector system can also be explained by introducing saving and investment and goods market and money markets.
  • 7. Stock and Flow Variables• Income is a flow and wealth is a stock• A flow variable has a time dimension (Rent, Wages, Interest, Profit-al are flows)• A stock variable has no time dimension (Money in Bank Account is a stock)
  • 8. Circular Flow of Economic Activities• Real circular flow-shows the flows of goods, services or factors of production form one sector to another.• Monetary circular-Shows the flows of money and Income from one sector to another.• Implications-Circular flow implies that total expenditure in the economy is identical to Gross National Product GNE=GNP Y=C+1+GE(Closed Economy)
  • 9. Circular Flow In An Open Economy• Circular flow in an open economy Y=C+1+G+(X-M) Where X=Exports of goods, services and capital M=Import of goods, services and capital National Income is the total market value of all final goods and services produced in an economy including net factor incomes from abroad during an accounting year. NNI at MP=GNP-Depreciation
  • 10. Injections and Leakages in Circular Flow• Important Injections• (I) Investment• (II) Exports• (III) Consumption expenditure by the households or the government
  • 11. Injections affect the economy in two ways• (i) Add to production capacity of the economy• (ii) Generate demand for the produced goods and services.• Accordingly, injections lead to accelerating the growth process and enhanced level of employment.
  • 12. Leakages• These are those variables which have a negative impact on the process of production (or on the process of income generation) in the economy. These are• (i) Savings• (ii) Imports