Circular Flow of Income Flashcards
What is the circular flow of income
- A model that represents the flow of money through an economy
- Can’t determine the external factors
Assumptions
- Economy consist of two sectors - households and firms
- Households spend all of their income (Y) on goods and services or consumption. There is no saving (S) out of current household income
- All the output (O) produced by firms is purchased by households through their expenditure (C)
- There is no financial sector
- There is no government sector
- There is no overseas sector
Inner flow
- Factor market
- Households flow of resources to firms - households provide labour for firms
□ E.g. teacher teaches for education department - Firm has an output - provides something to the households
□ E.g. education department gives education to households
Outer flow
- Product market
- Expenditure from households goes to firms
- Households spend money on firms
□ E.g. student swipes transperth card and spends money in return for transport - Income from firms goes to households
□ E.g. people get paid for labour
What is the real flow
Interior flow of goods and services
What is the exterior circle
money flow
What is income
- Money received for the provision of resources
- Includes wages, rent, dividends, profit, salary
□ Wages = paid by the hour
□ Salaries = paid by duty
□ Dividends = companies that choose to share parts of their company at a certain cost
What are resources
- Materials provided by households to firms
□ E.g. land, labour, capital, enterprise
What is equilibrium
○ The point where there is no change or variables - everything is as expected
○ The point where there is no tendency for the levels of income (Y), expenditure ( C ), and output (O) to change
○ Represented as Y=O=C
What is the three-sector model
○ Addition of the financial sector
○ Money comes out from households as savings
○ Money is injected into firms from the financial sector in the form of investment
What is the four-sector model
○ Addition of the government sector
○ Money leaks from households to the government sector in the form of taxation (T)
○ Money is injected to firms from the government sector in the form of government expenditure (G)
What is the five-sector model
○ Addition of the overseas sector
○ Money leaks from households to the international sector in the form of imports (M)
○ Money is injected to firms from the international sector in the form of exports (X)
What is the state of equilibrium
○ A state of equilibrium (balance) is desired within an economy
○ This is when the Leakages from the economy = injections
State of equilibrium equation
○ Y= C + I + G + (X-M)
OR
○ S + T + M = I + G + X
