eco chapter 1rst

1. Circular Flow of Income

2. Macro Economics
 Macroeconomics is a branch of economics field that studies
how the aggregate economy behaves.
 In macroeconomics, a variety of economy-wide phenomena
is thoroughly examined such as, inflation, price levels, rate
of growth, national income, gross domestic product and
changes in unemployment
 Useful to estimate National Income and Per Capita Income

3. National Income (N.I.)
 N.I. Is the aggregate money value of goods and services
produced in a country during a particular year
 It is the money value of all economic activities of a nation in
a given year
 Economy is in equilibrium when income = output =
expenditure

4. National Income (N.I.)
 Economic Activities in National Income
 Production
 Exchange
 Consumption
 Distribution
 Above Decisions are based on Economic Agents
 Households
 Firm

5. National Income (N.I.)
 Household
 Owners of Factors of Production
 Receive Income by supplying Services of Factors to Firms
 Firms
 Businesses who decide what, where, how and for whom to
produce to goods and services
 Receive Income by selling their output to household

6. Aspects of Circular Flow of N.I.
Real Flow Money Flow
 Movement of Factor
services from household
to firms
 Movement of Goods &
Services from firms to
Households
 Movement of money as
payment for factor
services from firms to
households
 Movement of money as
payment for goods &
services from household
to firms

7. Circular Flow of N.I.
 Closed Economy
 Two Sector Economy (Without Savings)
 Two Sector Economy (With Savings)
 Three Sector Economy
 Four Sector Economy / Open Economy

8. Closed Economy – Without Savings
 Assumptions
 2 Sectors only – Household and Firms
 Household owns Factors of Production
 Household receives payment for service of factors of production
 Production Activities take place in Firms Only
 Both Household and Firms have ZERO Savings
 No Govt Operations or International Trade

9. Closed Economy – Without Savings

10. Closed Economy – With Savings
 Assumptions
 2 Sectors only – Household and Firms
 Household owns Factors of Production
 Household receives payment for service of factors of production
 Production Activities take place in Firms Only
 No Govt Operations or International Trade

11. Closed Economy – With Savings

12. Closed Economy – With Savings
 Savings are leakage from the circular flow of economy
 Households save a part of their income in form of Bank Deposits
or financial investments etc.
 Firms borrow money from banks or financial institutions thus
converting household savings into real investments
 Thus savings is injected back in economy in the form of
investment
 When savings are made circular flow of income is disturbed due
to leakage but is restored as real investments are made on
account of injection

13. Three Sector Model
(Firms, Household & Govt)

14. Four Sector Model (Firms, Household,
Govt & External Sector)

15. Four Sector Model (Firms, Household,
Govt & External Sector)
 Savings, Taxes, Imports are leakages and Investment, Govt
expenditure and exports are injections
 Circular Flow of Economic Activities among 4 sector shows
that there will be equilibrium in all sectors when
 Savings = Investments
 Govt Expenditure = Taxes
 Exports = Imports

16. Four Sector Model (Firms, Household,
Govt & External Sector)
 To measure Circular Flow in various economies there are
various stages as follows
 Production Stage – Measured by Value of Output
 Income Stage – Measured by Earned Factor Income
 Spending Stage – Measured by Extent of total expenditure

17. Importance of Circular Flow of Income
 Gives Clear Picture of Economy
 Smooth Functioning of Economy
 Guidance in Restoration of Equilibrium
 Helps to Find Leakages
 Highlights importance of Policies (Fiscal & Monetary
Policies for equality in income & expenditure)
 Comprehensive Study of Economy’s Performance

18. Questions
 Analyze Circular Flow of Income in Closed Economy
 Elucidate Circular Flow of Income in Open Economy
 Explain Circular Flow of Income in 3 Sector Economy
 Importance of Circular Flow of Income in Economy