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THE CIRCULAR FLOW OF INCOME
Dr. SK LAROIYA
UNIV OF DELHIAND
AMITY BUSINESS SCHOOL
TO UNDERSTAND THE METHODS OF MEASURING
NATIONAL INCOME IT IS NECESSARY TO SIMPLIFY THE COMPLEX NET WORK OF
NUMEROUS TRANSACTIONS CONDUCTED IN A MODERN ECONOMY
A SIMPLIFIED MODEL OF AN ECONOMY CAN BE CONSTRUCTED
IN WHICH
ALL TRANSACTIONS ARE CLASSIFIED IN A FEW BROAD
CATEGORIES DERIVED SPECIFICALLY FOR MEASURING NATIONAL INCOME
SUCH A MODEL WITH ITS VARIANTS, WOULD REPRESENT OVERALL ECONOMIC ACTIVITY IN THE FORM OF WHAT MAY BE CALLED
‘THE CIRCULAR FLOW OF INCOME’
WITH THESE MODELS
WE CAN DEMONSTRATE MACRO ECONOMIC EQUILIBRIUM, SO VITAL FOR THE ECONOMIC POLICY FORMULATION AND ITS EFFECTIVE IMPLEMENTATION
FOUR MODELS:
1. BASIC MODEL2. WITH SAVINGS AND INVESTMENTS3. WITH GOVERNMENT4. WITH FOREIGN TRADE
BASIC MODELSupply of goods and services
Household sector
Business sector
Payment of factor incomes: wages, interest, rent and profit
Factor services: lab.,land, capital , enterprise
Expenditure on goods and services
ASSUMPTIONS:1. ONLY TWO SECTORS IN THE ECONOMY: BUSINESS
AND HOUSEHOLD SECTORS2. HOUSEHOLD SECTOR SPENDS ALL THE MONEY IT
RECEIVES3. ALL THE INCOME OF BUSINESS SECTOR IS
EXHAUSTED IN MAKING FACTOR PAYMENTS4. HOUSEHOLD AND BUSINESS SECTOR DO NOT SAVE
ANY MONEY AND PAY NO TAXES5. IT IS A CLOSED ECONOMY
WITHDRAWAL:
A WITHDRAWAL CONSISTS OF ANY PART OF INCOME GENERATED IN PRODUCING NATIONAL PRODUCT WHICH IS PASSED ON WITH IN THE ECONOMY
1. SAVINGS2. IMPORTS3. TAXES
INJECTION:
AN INJECTION IS AN ADDITION TO THE CIRCULAR FLOW OF INCOME
1. INVESTMENT2. EXPORTS3. SUBSIDIES4. GOVERNMENT EXPENDITURE5. TRANSFER PAYMENTS
Supply of goods and services
Household sector
Business sector
Payment of factor incomes: wages, interest, rent and profit
Factor services: lab.,land, capital , enterprise
Expenditure on goods and services--- withdrawals
+ injections
- withdrawals
+ injections
MODEL WITH SAVINGS AND INVESTMENTSSupply of goods and services
Household sector
Business sector
Payment of factor incomes: wages, interest, rent and profit
Factor services: lab.,land, capital , enterprise
Expenditure on goods and services--- Bus. savings
+ Investments
- HH. savings
+ injections
National income= C + S
S= SH +SB
SH = household savingsSB = busines savings
National product= C + I
For Equilibrium:
Y=C + SY= C + IS= I
MODEL WITH GOVT. SECTORSupply of goods and services
Household sector
Business sector
Payment of factor incomes: wages, interest, rent and profit
Factor services: lab.,land, capital , enterprise
Expenditure on goods and services--- Bus. savings
+ Investments
- HH. savings
+ injections
-- Taxation
+Govt. exp. Inc.subsidies
Y= C+S+TY= C+I+GT=TAXESG=GOVT. EXPENDITURE
Y=C+I+GFOR EQUILIBRIUMC+I+T=C+I+GS+T=I+GS+(T-G)=I
MODEL WITH FOREIGN TRADE SECTORSupply of goods and services
Household sector
Business sector
Payment of factor incomes: wages, interest, rent and profit
Factor services: lab.,land, capital , enterprise
Expenditure on goods and services--- Bus. savings
+ Investments
- HH. savings
+ injections
-- Taxation
- Imorts
+Exports
+Govt. exp. Inc.subsidies
Y=C+S+T+MY=C+I+G+XFOR EQUILIBRIUMC+S+T+M=C+I+G+XS+T+M=I+G+XS+T=I+G+(X-M)X-M IS NET FOREIGN INVESTMENT.
PUTTING IF FOR X-MAND ID FOR DOMESTIC INV.
WE HAVES+T= ID+G+IFS+(T-G)=ID+IF
SO IN FOUR SECTOR MODEL WE HAVE
S+(T-G)=ID+(X-M)