Chapter 5. Circular flow NI
Chapter 5. Circular flow NI
MARKETS
Revenue FOR Spending
GOODS AND SERVICES
•Firms sell
Goods Goods and
•Households buy
and services services
sold bought
FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production
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Two-Sector Model
The Circular Flow of Income in a Three – Sector Model
• The three sector model of circular flow of income highlights the role
played by the government sector. This is a more realistic model which
includes the economic activities of the government however; we continue
to assume the economy to be a closed one. There are no transactions
with the rest of the world. The government levies taxes on the
households and the firms and it also gives subsidies to the firms and
transfer payments to the household sector
• In this model, the equilibrium condition is as follows:
• Y=C+I+G
• Where, Y = Income; C = Consumption; I = Investment and G = Government
Expenditure
Three – Sector Model
Three – Sector Model
The Circular Flow Of Income in a Four Sector
Model
• This is the complete model of the circular flow of income that
incorporates all the four macroeconomic sectors. Along with the above
three sectors it considers the effect of foreign trade on the circular flow.
With the inclusion of this sector the economy now becomes an ‘open
economy’. Foreign trade includes two transactions, i.e., exports and
imports
• In this model, the equilibrium condition is as follows:
• Y = C + I + G + NX
• NX = Net Exports = Exports (X) – Imports (M)
Four Sector Model
Four Sector Model
Leakages and Injections in the Circular Flow of
Income
The flow of income in the circular flow model does not always remain constant. The volume of
income flow decrease due to the leakages of income in the circular flow and similarly, it increases
with the injections of income into the circular flow.
Leakages: A leakage is referred to as an outflow of income from the circular flow model. Leakages
are that part of the income which the household withdraw from the circular flow and is not used to
purchase goods and services. This part of the income does not go to the goods market. There are three
main leakages and these are:
• Saving:
• Taxes
• Imports
• Thus, we see that leakages reduce the volume of income from the circular flow of income.
• Leakages = S + T + M
• Where, S = Saving; T = Taxes; and M = Imports
Injections: An injection is an inflow of income to the circular flow. The
volume of income increases due to an injection of income in the circular flow.
There are three main injections and these are:
• Investment:
• Government Expenditure:
• Exports:
• Injections = I + G + X
• Where, I = Investment; G = Government Expenditure; and X = Exports
Balance of leakages and Injections in an open economy is;
S + T + M = I + G + X Or, (S –I) = (G – T) + (X – M) The
Leakage and Injection
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