CIRCULAR FLOW OF INCOME & EXPENDITURE WITH GOVERNMENT

Prepared by: Taruna Dureja Banga

Micro & Macro Economics

Micro Economics
Definition - Studying a part of economy, a unit or

particular, specific aspects Characteristics: Study of individual Determination of individual prices Small variables Immediate disposal of the problem Immediate decisions are possible

Micro versus Macroeconomics

Microeconomics: behavior of individual economic units

like consumers, producers, landowners, families, etc. How and why do they make the decisions?
Macroeconomics: analyzes how the entire national

economy performs. It analyzes unemployment, inflation, price levels, interest rates .

National Income
National income is a measure of the total flow of

earnings of the factor-owners through the production of goods & services. In a simple way, it is the total amount of income earned by the citizens of a nation

Circular flow of income

Circular flow of income or circular flow refer to a simple economic model which describes the reciprocal circulation of income between producers and consumers. In the circular flow model, the inter-dependent entities of producer and consumer are referred to as "firms" and "households" respectively and provide each other with factors in order to facilitate the flow of income. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households.

The circular flow of income

The interdependence of goods markets and factor markets

Circular-Flow of Economic Activities

A household is a person or a group of people

those supply factors of production in the form of land, labour, capital, enterpreneur.
A firm is an organization that produces goods and

services for sale and make factor payments to households for using its services..
Firms sell goods and services that they produce to

households.
Firms buy the resources they need to produce

factors of productionfrom factor markets.

The interdependence of goods and factor markets

FIRMS (suppliers of goods and services, demanders of factor services) HOUSEHOLDS (demanders of goods and services, suppliers of factor services)

The Circular-Flow Diagram in a two sector economy

Revenue

Goods & Services sold

Market for Goods and Services

Spending Goods & Services bought

Firms

Households

Inputs for production

Wages, rent, and profit

Market for Factors of Production

Labor, land, and capital

Income

The Circular-Flow Diagram

The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle

The Government Sector

Government taxation (T) reduces households

disposable income and business funds

Government spending (G) includes

expenditure on wages and salaries to households and subsidies to the firms for carrying out production activities.

Three Sector Model

CIRCULAR FLOW OF INCOME in four sector economy WITH SAVINGS ,(GOVERNMENT TAXES AND WORLD ECONOMY, HOUSEHOLDS AND FIRMS)

The circular flow of income

Firms
INJECTIONS
Export expenditure (X) Investment (I) Government expenditure (G) BANKS, etc GOV. ABROAD

Factor payments

Consumption of domestically produced goods and services (Cd)

Net saving (S)

Import Net expenditure (M) taxes (T)

WITHDRAWALS

Households

Leakages and Injections

Leakages in the circular flow: Flows out of circular

flow when resource income is received and not spend directly on purchases from domestic firms Savings(S) Taxes(T) Injections in the circular flow: Added spending in circular flow that does not come out of current resource income Investment(I) Government spending(G)

Savings and Investment

If planned (I+G) = planned (S+T)

so that injections = leakages and total spending = total income and demand = supply
then

we have a stable economy

Contracting Economy
If leakages are than injections (Planned S+T > Planned I+G), economy contracts resulting in
inventory accumulation

Higher

too little spending

drop in prices

Expanding Economy
If injections are

Higher than leakages

(Planned I+G > Planned S+T), economy

expands resulting in
more goods and services produced

higher prices

Government and the Circular Flow

Balanced budget:
amount spent by government (G)= amount

collected in taxes(T)
Surplus budget
amount spent by government (G)< amount

collected in taxes(T)
Deficit budget
amount spent by government (G)> amount

collected in taxes (T)

Any Queries