2- Circular Flow of Income

Question 1

Barter economy

Answer 1

An economy with just 2 people exchanging goods

Question 2

Problem with barter

Answer 2

• Inefficient - double coincidence of wants needed
• Money created and therefore fundamental

Question 3

Properties of traditional circular flow of income

Answer 3

• A closed system
• No leakages or withdrawals

Question 4

Francois Quesnay circular flow model

Answer 4

Francois Quesnay (1694-1774), divided (French) society into three social classes:
1 landlords (idle class), draw rent from ownership of land
2 artisans (sterile class), spend what they earn
3 farmers (productive class), save (seed corn) for investment.
- Quesnay said that these 3 groups were the most productive in French society and these groups can’t be taxed more.
- The only way to increase productivity in the economy is by improving productivity in agriculture.

Question 5

The modern circular flow

Answer 5

The modern economy is assumed to consist of households and firms.
Firms produce goods and services and sell them to households;
Households consume goods and services and sell labour (and other factor) services to the firms.

Question 6

Differences between Modern and Quesnay Circular Flow

Answer 6

• All market transactions result in added value not just agriculture.
• With simple, modern model – total factor income=total consumption expenditure

Question 7

Full Circular Flow of Income Explanation

Answer 7

1. Households provide factor services to firms receiving income in return.
2. Households spend their incomes on the final output of firms.
3. 2 additional flows one of for injections and one for leakages.
4. The government raises taxes from households and firms, which
   it spends on the output of firms, subsidies to firms, transfer
   payments (pensions, benefits etc) and factor incomes (wages)
   to households.
5. The government may also save some tax revenue it receives to
   contribute to gross investment (e.g. hospitals, schools and
   infrastructure)

Question 8

What are injections?

Answer 8

• All sources of final spending on firms’ output that doesn’t arise from the spending of domestic households.
• These are spending on consumers by government, on investment by firms and on exports by foreign sources.

Question 9

What are leakages?

Answer 9

• The part of household income that doesn’t end up as spending on the output of firms.
• These are taxes paid to the gov, savings and imports.

Question 10

3 ways to measure national income

Answer 10

• Income measure
• Output measure
• Expenditure measure

Question 11

Circular Flow of Income Overview/Summary

Answer 11

• The circular flow of income shows domestic incomes earned by households giving rise to spending which in turn gives rise to the output of firms, which creates incomes for households.