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Notes- Video - Coggle Diagram
Notes- Video
The Basic Circular Flow Model
The basic circular flow is between households and firms
Households are buying goods and services, thus it causes a flow of demand into the business sector
Firms are supplying goods and services, producing the output.
Firms generate a flow of factor incomes back to the household sector, in the forms of wages, salaries, rent income, interest on savings, share of profits etc.
The circular flow model is essentially a series of flows between households and businesses with feedback loops
Governments receive income in the form of taxes from households (leakage)
Direct taxes- such as Income tax
Indirect taxes- duties of alcohol and cigarettes
Governments also inject money into the circular flow through social transfers
Welfare benefits- such as state pension, employment assistance, housing benefits
Injections & Leakages within the Circular Flow
Leakages/Withdrawals- Money leaving the circular flow
Taxation
Imports
Savings by households
Injections- Ways through which extra demand or money can come into the circular flow
Business investments
Government spending
Exports
Leakages tend to depress or deflate the level of demand and output
Injections add to demand in the circular flow and inflate the value or the volume of production in the economy
When the rate of injections is equal to the rate of withdrawals, it can be said that the circular flow effectively is in balance.
If injections are greater than leakages, the level of national income or GDP will increase
If the rate of leakage is greater than injection, then that will cause the level of GDP to fall or to contract
The Four Key Parts of the Circular Flow Model
Businesses
Hire factors of production
Land
Labour
Capital inputs
Supply goods and services
Receive payment from consumers that creates revenue and profits
Income in the form of wages and salaries
Government
Collects taxes to fund their collective spending on public and merit, goods, education, health and defense and to provide welfare support
Households
Buy goods and services produced by firms
consumer spending
Receive income from their work or investments in the form of wages and salaries
External sector
Businesses are exporting goods and services, generating inflows of foreign currency.
Consumers, businesses and governments are importing goods and services from other country.
Circular Flow with an External Sector
Money leaves the circular flow in the form of imported goods and services, with the inflow of products.
Businesses are exporting goods and services to other consumers in other countries and the money from exports flows back into the circular flow.
It can be considered an injection of additional agrregate demand, making the external sector particularly important
An example of this is the UK, where nearly 2/3 of the value of the GDP is linked directly to the value of exports or the value of imports, proving the external sector important
Financial Sector Added to the Circular Flow Model
The financial sector is a way of channeling the savings of households and businesses and repackaging those savings in the form of loans and other forms of finance to fund the economy, such as business investments.
The commerical banking is an important aspect
Business investment is an injection into the circular flow
Domestic Circular Flow of Income & Spending
Important relationship between firms and governments
Government receives its income from firms through corporation taxes, environmental taxes etc.
Injection of government spending into the business sector is greater.