The unsold output leads to the increase in the inventories of goods and in national income accounting increase in inventories of goods is treated as a part of actual investment. So there is a circular flow of income in between two sectors — household sector and firm sector. When households and firms save part of their incomes it constitutes leakage. He needs a place to stay and he needs food to eat. This can be represented by the money flow from the financial market to the Government and is labelled as Government borrowing To avoid confusion we have not drawn this money flow from financial market to the Government. It is business firms who borrow from the financial market for investment in capital goods such as machines, factories, tools and instruments, trucks.
Since the first assumption is relaxed there are three more sectors introduced. Many goods can be justified as intermediate as well as final goods depending on their use. On the contrary, in case of import surplus, that is, when imports are greater than exports, trade deficit will occur. The money flow from households and business firms to the government is labelled as tax payments in Fig. We don't quite know what that is yet because we have to figure out how much profit he's getting from the firm.
Subsidies have the opposite effect of taxes. Income Phase- Producing firms earn revenue from the sale of goods and services produced by them. A result, circular flow of money speeding and income remains undiminished. It is these actual or realised saving and investment that are identical in national income accounts. Ecological Economics: Principles and Applications. All these institutions together are called financial institutions or financial market.
In case of cash deficit, the government borrows from the capital market to maintain a balance in the economy. In other words, we have expenditure- side transaction. An example of a tax collected by the government as a leakage is and an injection into the economy can be when the government redistributes this income in the form of , that is a form of government spending back into the economy. Money acts as a helping agent in such an exchange. On the contrary, flow of money expenditure on exports of a domestic economy has been shown to be taking place from foreign countries to the business firms of the domestic economy. The circular flow of income in different sectors can be expressed as follows: Household Sector Receipts The household sector receives factor income in the form of rent, wages, interest, and profit from the business sector. If value of exports exceeds the value of imports, trade surplus occurs.
Circular Income Flow in a Three Sector Economy with Government : In our above analysis of money flow, we have ignored the existence of government for the sake of making our circular flow model simple. In case exports exceed imports, the economy faces a deficit balance of payment. The main injection provided by this sector is the exports of goods and services which generate income for the exporters from overseas residents. Tax is included in the price of a commodity and tax is not a production. This is not to say that the circular flow diagram isn't useful in understanding the basics of an economy, such as leakages and injections. Transfer payments are treated as negative tax payments. In order to make our analysis simple and to explain the central issues involved, we take many assumptions.
The end result of this disequilibrium situation will be a higher level of equilibrium. It makes payments for import of goods and services from firms and the government. In other words, Government borrowing crowds out private investment. Thirdly, we assume that the economy neither imports goods and services, nor exports anything. By net capital inflow we mean foreigners will borrow from domestic savers to finance their purchases of domestic exports. In the example of meat production, the value of the good from the farm may be P10, then P30 from the butchers, and then P60 from the supermarket.
These are the goods and services up here. Level of development is also measured by using national income figures. Business firms consider the interest rate as cost of borrowing and the rise in the interest rate as a result of borrowing by the Government lowers private investment. National Income Accounts : Economic growth of any country is measured by its growth of national and per capita incomes. In opposite direction to this, money flows from business firms to the households as factor payments such as wages, rent, interest and profits. In this way the economy functions. The circular flow of income described above is the most simplistic illustration of the interdependency of two sectors in the economy.
This simplistic model suggests the old economic adage that supply creates its own demand. The national product or national income measures the overall economic performance of a nation. Here flows from household sector and producing sector to government sector are in the form of taxes. In other words, national income is the yardstick of measuring the growth performance of any economy. For this purpose, then private investment I by business firms must be less than the savings S of the households. Payments The government sectors make payments to different sectors in the form of transfer payments, subsidies, grants, etc. In almost all economies, the government plays an active part.