chapter 2 circular flow of income. production process through which raw materials are converted...
TRANSCRIPT
Chapter 2
Circular Flow of Income
Production Process through which raw materials are converted into output using
factors of production
Economic Activities
Consumption Process of utilisation of goods and services to satisfy human wants
Accounted for at the time of purchase of product, even though service may be provided over a period of time
Economic Activities
Capital Formation Excess of Production over Consumption Also termed as investment Improves the productive capacity of a nation
Consumption Capital Formation
Production = Consumption + Capital Formation
Production
Economic Activities
Flow Variables Measured over a period of
time Eg:
Profit & loss of a company Birth rates & death rates Income of an individual
Stock Variables Measured at a point in
time Eg:
Balance Sheet of a company Population Wealth of an individual
Stock vs Flow Variables
Changes in stock variables occur
due to
changes in flow variables
Households Owners of factors of production Provide factor services to firms Receive factor income in return Spend income on goods and services (consumption)
Sectors in an Economy
Firms Include both private and government owned Hire factors of production to undertake production of goods and services Sell output and generate income Income paid to factors of production
Government Refers to the ‘general government’ Receives taxes from households and firms Spends money on provision of services that improve welfare Profit is not an objective
Sectors in an Economy
Rest of the World External economy Domestic economy undertakes transactions with the external economy
• Imports – purchase of foreign products by domestic economy• Exports – sale of domestic products to external economy
Production (generation of
income within a production unit)
Meaning of Circular Flow of Income
Production (generation of
income within a production unit)
Income (distribution of
income to factors of production)
Meaning of Circular Flow of Income
Production (generation of
income within a production unit)
Expenditure (disposal of income by
households)
Income (distribution of
income to factors of production)
Meaning of Circular Flow of Income
Production (generation of
income within a production unit)
Expenditure (disposal of income by
households)
Income (distribution of
income to factors of production)
Meaning of Circular Flow of Income
PRODUCT MARKET
Goods & Services
Payment for Goods & Services
Payment of factor income
Factor Services
FACTOR MARKET
The Circular Flow of Income – 2 Sector Model
Goods and Services
Factor Services
Money FlowsRepresent the flow of money in the economy
Real FlowsRepresent the flow of goods and services including factor services in the economy
The Circular Flow of Income – 2 Sector Model
Payment for goods & services
Payment of factor income
PRODUCT MARKET
FACTOR MARKET
Savings : Residual income that households do not use to purchase goods and
services
Two Sector Model with Financial Sector
FINANCIALSECTOR
Savings
(Leakage)
Investment
(Injection)
Investment : Expenditure on capital goods
Goods and Services
Factor Services
Payment for goods & services
Payment of factor income
PRODUCT MARKET
FACTOR MARKET
Three Sector Model
Financial SectorSavings
(Leakage)
Investment
(Injection)
Goods and Services
Factor Services
Payment for goods & services
Payment of factor income
PRODUCT MARKET
FACTOR MARKET
Equilibrium is achieved when leakages = injections
Savings + Taxes = Investment + Govt. Purchase + Payments
GOVERNMENT(Leakage) (Leakage)
Taxes
Factor payments & Transfer payments
Government purchases & subsidies
(Injection) (Injection)
Taxes
Four Sector Model
FinancialSector
Savings
(Leakage)
Investment(Injection)
Goods and Services
Factor Services
Payment for goods & services
Payment of factor income
PRODUCT MARKET
FACTOR MARKET
Government(Leakage) (Leakage)
Taxes
Factor payments & Transfer payments
Government purchases & subsidies(Injection) (Injection)
Taxes
In Equilibrium : Leakages = InjectionsSavings + Taxes + Imports = Investment + Govt. Expenditure & Transfers + Exports
Rest of the World
Payment for Imports(Leakage)
Factor Income (Injection)
Payment for Imports(Leakage)
Export Receipts (Injection)
Factorpayments
Payment for goods and services
Financial Sector Govt
.ROW
Investment (I)Investment (I)
GovernmentGovernmentexpenditure (expenditure (GG))
Exportexpenditure (X)
NetNetsaving (S)saving (S)
NetNettaxes (T)taxes (T)
ImportImportexpenditure (M)expenditure (M)
WITHDRAWALSWITHDRAWALS
INJECTIONSINJECTIONS
Circular Flow of Income - Summary