circular flow of economic activity edited
TRANSCRIPT
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CIRCULAR FLOW OF
ECONOMIC ACTIVITY
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Overview
IntroductionThe two sector modelThe three sector modelThe four sector model
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Introduction
In economics, the term circular flow of income or circular flow of economic activity refers to a simple economic model which describes the circulation/flow of income between producers and consumers
In the circular flow model, producer and consumer are referred to as "firms" and "households" respectively
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Basic terms
In the present mixed economic system we find three basic
economic units.
Households Firms/Business Government Foreign market
Households:
It is a person or a group of people that share their income.
The members of households have two functions: they supply different factors of productionmembers of household also work as consumers
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Firms:
An organization that produces goods and services for sale.
Regarded as the economic units whose main objective is to
maximize profit in the production process. The three main
functions are as follows:• Produce goods and services and supply them in the
market.• Firms purchase inputs or raw materials from households
to use them in the production process.
Government:
Just like households and firms the government also earns incomes and makes expenses. Two major functions played are:• Government earns revenue either from tax or non-tax
sources both from households and firms.
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Government provides essential public services such as maintenance of law and order, defense services, judiciary etc
Foreign Market:
It consists of two kinds of international economic
transactions i.e. export and import of goods and services
and inflow and outflow of capital.
Financial Institution : consists of banks and non-bank intermediaries who
engage in the borrowing (savings from households) and lending of money.
the leakage that financial institutions provide in the economy is the option for households to save their money.
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Two Sector Model
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Assumptions
Households: To own all the factors of production To consume all final goods and services Their income consists of wages, rent, interest and profits
Business firms: To hire factors of production from households Produce and sell goods and services goods to the
households No corporate saving
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Factor Markets:Flow of factors like land, labor, capital and organization
is
observed from households to firms and in return they
receive factor income like rent, wages, interest and profits
from firms.
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Product Markets: These transactions show money flow from households
to
firm. Households purchase consumer goods and services
from firms and in exchange they make payments to firms.
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Two Sector Model
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FACTOR PAYMENTS = HOUSEHOLD INCOMES and
HOUSEHOLD EXPENDITURE= TOTAL RECEIPTS OF THE FIRM
So HOUSEHOLD INCOMES = FACTOR PAYMENTS = MONEY VALUE OF OUTPUT
Effects of Withdrawal and Injections
Withdrawals : an amount set aside by the households
and/or by the firms, not to be spent on the goods and
services over a period of time. It is not a saving rather it
reduces the volume of the circular flow.
Injections : the amount that is spent by the households
and/or firms in addition to their current incomes
generated within the regular economy. It increase the
size of the flow
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Three Sector Model
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Three Sector Model
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Introduction
Three sector model is created by adding the Government sector to the Two sector model
Three kinds of monetary flows between the government and the rest of the economy i.e.
1)direct taxes on both households and firms
2)government expenditure
3)transfer payments and subsidies
Government spends a part of its tax revenue as ‘factor payments’ to the households and a part in the form of transfer payments as pension and food subsidy etc
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Four Sector Model
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Export/ Import Market
Financial Institutio
nsGovernment
Four sector model
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Introduction
This circular flow of model shows the four macroeconomic
sectors of the economy i.e.
household, business firm, government, and foreign. These four sectors capture four fundamental
macroeconomic functions and their expenditures are
combined together to purchase the economy's total
production.
Assumptions: To introduce the financial market first and assumes
household saves in the financial market.
There are no inter-households borrowing.
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If the households save a part of their income in the financial market (such as banks, insurance companies, stock market etc), this reduces the expenditure of Household on goods and services
Ultimately reduces the flow of money/income of the economy. So saving known as the leakage of the economy
Again the business firms borrow from the financial markets for investment in the capital goods (such as machineries, factories, tools, instruments etc)
This ultimately increases the productive capacity of the business firm. So investments are known as the injection for the economy
Through this investment expenditure the saving of the households deposited in the financial market are again bought into the expenditure stream and circular flow of economic activity continued
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Government Sector:
Government purchases goods and services just as households and firms do.
It also borrows from the financial market.
Also collects money from firm and household through taxes.
This money of the Government again spends in the economy in the form of expenditure on the capital goods and infrastructure (such as highways, power, communication etc).
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Foreign Market(export and import):
Goods and services produced within the domestic territory which are sold to the foreigners are called exports.
On the other hand, purchases of foreign made goods and services by domestic households are called as imports.
Here we assume that only business forms can interact with the foreign countries and dealt with the export and import of the country. Money goes through import from the economy again returned back to the country through export activities
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THANK YOU
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Presented By:
Uma LakhotiaChitrak PalRaashi
ChoudharyBidisha GhoshPooja ChatterjiShilpi Dutta