Year 12 Economics: 2.3 Circular Flow Model Slideshow

Explanations and Applications of the Circular Flow Model in relation to Economic Growth.

By David Yan

12 Economics

KRR

PLANNING: Part One – Planning

A: Five sector Circular Flow model that includes all money and real flows

HOUSEHOLDS

PRODUCERS

OVERSEASSECTOR

GOVERNMENTSECTOR

FINANCIALSECTOR

LABOUR

GOODS & SERVICES

Savings (S)

Loans for Investment (I)

Consumption (C)

Income (Y)

Taxes (T)

Govt.

Spending (G)

Taxes (T)

Transfers (Tr)

ExportReceipts (X)

ImportPayments (X)

Part One – PlanningB: Description of Each Sector

Financial Sector:

Financial institutions – banks and other organisations that help channel money (as intermediates) from savers to borrowers.

Government Sector:

Includes Parliament and many other organisations such as government departments, ministries and state owned enterprises

Household Sector:

The sector that provides resources for productions (factor inputs) and buys final goods and services (consumer G+S)

Overseas Sector:

The sector containing overseas buyers of exports and suppliers of imports

Producer Sector:

The sector responsible for the production of goods and services.

Part One – PlanningC: Difference of Each Sector

The household sector is the sector that provides savings to the financial sector, consumption to the producer sector and taxes to the government sector. They also provide labour (factor inputs of production) to the producer sector whereas;

the producer sector provides income to the household sector, taxes to the government sector and import payments to the overseas sector. The producer sector also provides goods and services to the household sector whereas;

the financial sector provides loans for investments to producers whereas;

the government sector provides transfers to the household sector as well as government spending to the producer sector whereas;

the overseas sector provides export receipts to the producer sector.

Part One – PlanningD: Why Injections are Important for Growth

Injections are important for economic growth because they have flow-on effects in the circular flow which cause eventual growth. These effects start at the point in which the money from the injections enter and flow-on to cause changes in other sectors. Injections are money entering the circular flow, for example transfers, subsidies, government spending and export receipts.

For example; if the event of an injection of money from export receipts would occur, producers will now receive more income and therefore more profit. This results in the flow on effect of the government sector both receiving more taxes, and increasing transfers and government spending. Producers also now have more to spend on income to households, resulting in more employment. Households will in return increase consumption. These effects further flow-on and result in growth.

G R O W T H

PRESENTATION: Part Two – Presenting

1: What is the circular flow model, and what are the assumptions and limitations of it as an economic model?

HOUSEHOLDS

PRODUCERS

OVERSEASSECTOR

GOVERNMENTSECTOR

FINANCIALSECTOR

LABOUR

GOODS & SERVICES

Savings (S)

Loans for Investment (I)

Consumption (C)

Income (Y)

Taxes (T)

Govt.

Spending (G)

Taxes (T)

Transfers (Tr)

ExportReceipts (X)

ImportPayments (X)

Part Two – PresentingThe Circular Flow Model (CFM) is an economic model that illustrates the independence that exists between the different sectors operating in an economy. These sections are the Household Sector, the Producer Sector, the Government Sector, the Overseas Sector and Financial Institutions. It is usually used to show the flow of money (money flows) or the flows of commodities and resources (real flows) between the sectors of an economy. Usually the circular flow can be used to illustrate flow on effects and what they can result in, for example the flow on effects of injections in the circular flow.The Circular Flow Model, like other models, has limitations and takes assumptions. It is assumed that all output of producers is purchased (or consumed) by the Household Sector. The Circular Flow Model is only a theoretical representation of an economy, which in itself is a significant limitation. The assumptions in which the Circular Flow Model is based on are limitations also as they mean information will not be always correct and/or relevant. For example the Circular Flow Model does not show what happens to the output that is not consumer by the Household Sector.

Therefore any theories derived from, or based on the Circular Flow are under jeopardy for the reasons of limitations and assumptions because they restrict the relevance and the actual accuracy of the information that is being presented as fact.

Part Two – Presenting2: The differences between the five sectors of the economy – using diagrams.

The five sectors of the economy; the Financial Sector, the Government Sector, the Household Sector, the Overseas Sector and the Producer Sector have many distinct differences. They all provide and receive different things – all of which are demonstrated in the circular flow diagram. What they provide and receive are both money and real flows. They all have the similarity of being interdependent of each other as each single sector has flow on effects which result in significant changes for the other four sectors in the circular flow module, whether they are indirectly or directly.

*The household sector is the sector that provides savings to the financial sector, consumption to the producer sector and taxes to the government sector. They also provide labour (factor inputs of production) to the producer sector whereas;* the producer sector provides income to the household sector, taxes to the government sector and import payments to the overseas sector. The producer sector also provides goods and services to the household sector whereas;* the government sector provides transfers to the household sector as well as government spending to the producer sector whereas;* the financial sector provides loans for investments to producers whereas;* the overseas sector provides export receipts to the producer sector.

Part Two – Presenting3: The differences between injections and withdrawals.

Injections and Withdrawals are both important in the circular flow module. They both result in flow-on effects which eventually cause growth (for injections) or contractions; a decrease in growth (for withdrawals). The difference between them is the fact that injections are inputs of money into the circular flow diagrams from an external source, for example if the overseas sector purchases from the producer sector there is an injection of money into the circular flow. The same applies if the government sector increases government sector.

If there is an injection, flow-on effects cause positive changes which lead to an increase in growth, where as if there is a withdrawal, flow-on effects instead cause negative changes to the economy which lead to a decrease in growth; known as a contraction.For example, if the government sector decreased government spending or decreased subsidies, then the flow-on effects of these withdrawals would then occur which when they do subsequently decrease growth.

Part Two – Presenting4: The reason why injections are important for economic growth.

Injections such as an increase in subsidies or government spending from the government sector or an increase in export receipts have flow-on effects which result in the increase of growth in an economy. For example, if the government were to increase subsidies for bus rides, the producer sector would now be earning more profit due to either the same revenue with the now lowered expenses or an increased customer base due to the decrease in price of bus rides. The consumers; i.e. those who take the bus, would most likely now have more savings as a result of this change, which in turn results in more savings which increase savings to the financial sector which result in more loans for investments being given to producers. These effects are flow-on, which mean they tend to be cyclic in nature. These effects cause growth in our economy as a result of injections and therefore are essential for growth to be possible in the economy.

Part Two – Presenting5: How an increase in household savings causes economic growth.

As a result of an increase in household savings, savings increase, and this results in the financial sector having more money to loan out to firms, which can now increase investments. Firms buy more capital goods as they now have more to invest, and therefore have increased productivity due to the increase in capital goods – which result in increased productivity for firms, as production is now more efficient. Growth therefore occurs because the productive capacity of the economy has increased.

6: How an increase in firms’ investment causes economic growth.

As a result of an increase in investments due to the financial sector receiving more savings from households, and this results in more resources being purchased as households increase their consumption as their savings increase. The producers sector will also increase the amount of goods and services produced due to the now increased demand. Growth therefore occurs because the productive capacity of the economy has increased.

Part Two – Presenting7: How an increase in resource use causes economic growth.

As output increases, the amount of resources required increases as an increase in output involves an increase in resources being used to produce goods and services which the household sector consumes. This results in household/consumer income increasing as they provide the resource of labour to receive income from the producer sector. The level of goods and services produced now increase due to the output increasing and consumer spending now increases as more is being purchased. Growth therefore occurs because the productive capacity of the economy has increased.

8: How an increase in consumption causes economic growth.

As a result of an increase in consumption, due to increased income or decreased taxes, spending on goods and services increases since consumption has increased and is directly related to spending on goods and services, firms will be more confident due to their increased success and increase output due to higher demand from the household sector and more confidence. Investments will now increase due to firms making more profit and incomes increase as more labour is required to increase output, and the household sector is given income in return for which they provide labour. Household savings increase due to increased income. Growth therefore occurs because the productive capacity of the economy has increased.

Part Two – Presenting9: How an increase in exports causes economic growth.

Exports will increase due to New Zealand’s market being able to offer goods and services at a price lower than other countries in the World market. Export receipts increase due to the increase in exports and firms have an increase in profit due to the increase in exports. They now increase investments due to the increased profits and output will also increase as investments involves the purchasing of capital goods which in turn increases productivity and the efficiency of output of the firms. Household incomes will not increase as more income is being provided by the firms to pay for the labour they now need to keep up with new demands of output. Growth therefore occurs because the productive capacity of the economy has increased.

Part Two – Presenting10: How an international event being held in NZ causes economic growth.

An international event being held in New Zealand results in an increase in tourism, so export receipts increase as the increase in tourism results in goods or services produced in New Zealand by New Zealand firms in the producer sector being exported to overseas consumers. Spending in the region increases due to households’ increased income following more income being paid in exchange for labour which producers now need due to increased output. Firms’ confidence increases so investments increase as more profits are being made by the firms. Income increases due to the household sector proving more labour which is required by firms to produce the new levels of output. Spending therefore increases due to the increased income and growth occurs as the productive capacity of the economy has increased.