Circular flow of income,leakage and injections.

VIJETH S KUMARMACFAST

Circular flow of income?????

• 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.

Measurement of National Income- National income is an estimation of aggregation of any of economic activity of the circular flow. It is either the income of all the factors of production or the expenditure of various sectors of economy.

Knowledge of Interdependence- Circular flow of income signifies the interdependence of each of activity upon one another

Unending Nature of Economic Activities- It signifies that production, income and expenditure are of unending nature, therefore, economic activities in an economy can never come to a halt. National income is also bound to rise in future.

To understand about the leakages in economy and injections

Significance of Study of Circular Flow of Income

Household

Firms/business

Government

Foreign sector

Financial institutions

Determinants

HOUSE HOLD

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 production

members of household also work as consumers

FIRMS

Firms:An organization that produces goods and services for sale. main objective is to maximize profit in the production process. The two 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

GovernmentJust 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.

Government provides essential public services such as maintenance of law and order, defence services, judiciary etc.

FINANCIAL INSTITUTIONS

Financial institutionsFinancial 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.

Foreign sector

Foreign Market: It consists of two kinds of international economic transactions i.e.

export and import of goods and services

inflow and outflow of capital.

Have a glance on

Two sector model

Three sector model

Four sector model

Five sector model

TWO SECTOR MODEL

Three sector modelThree 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 firms2)government expenditure3)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.

FOUR SECTOR MODEL

Govt borrowings

This circular flow of model shows the four macro economic sectors of the economy i.e. household, business firm, government, and financial institutions.

These four sectors capture four fundamental macroeconomic functions and their expenditures are combined together to purchase the economy's total production.

Ultimately it reduces the flow of money/income of the economy.So saving known as the leakage of the economy

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

To introduce the financial market, it is assumed that household saves in the financial market.

There are no inter-households borrowing

FIVE SECTOR MODEL

Foreign Market(export and import):

Goods and services produced within the domestic territory which are sold to the foreigners are called exports.

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 return back to the country through export activities.

Leakage Injection

Savings Investments

Taxes Govt. spending

Imports Exports

 In terms of the circular flow of income model the leakage that financial institutions provides an option for households to save their money.

This is a leakage because the saved money can not be spent in the economy and thus it is an idle asset, that means no output will be purchased.

The injection that the financial sector provides into the economy is investment (I) into the business/firms sector.

Why savings become a leakage??????

Tax is paid to Government by households and firmsTax is a leakage because it is a leakage out of the current income and reduces the expenditure on current goods and services

The injection provided by Government on this leakage is Government spending( services and welfare payments to the community)

For e.g.. Income tax collected by Govt is a leakage and Govt spends some amount as food subsidy as an injection.

How tax becomes a leakage?????

Imports are leakage because it is the spending by residents into the rest of the world.

It becomes a leakage because the money in the home market goes to countries abroad.

The main injection provided by this sector is the exports of goods and services which generate income for the exporters from overseas residents. 

How Imports becomes a leakage?????

In five sector circular flow of income model, the state of

equilibrium occurs when the total leakages are equal to

the total injections that occur in the economy.

This can be shown as:

Savings + Taxes + Imports = Investment + Government

Spending + Exports

S + T + M = I + G + X.

THANKYOU