In fact, the basis of the Keynesian multiplier is the cumulative movements in the circular flow of income. In this way, the circular flows of income and expenditure remain in equilibrium. A primitive economy will primarily be based on the primary sector — with most people employed in agriculture and the production of food. If total leakages exceed total injections the level of spending in the economy will fall leading to the decline for goods and services leading finally to unemployment. Students may investigate the organizations on the internet to help determine the economic sector.
Transfer payments are treated as negative tax payments. Determination of Equilibrium Income or Output In a Three Sector Economy Though the government is involved in a variety of activates three of them are of greater relevance to us in the present context. The three sector model can be described in the following diagram: If the government spends all its income received in the form of taxes, it flows back to the household and business sector in the form of subsidies and other government expenditures. This is quite unrealistic because government absorbs a good part of the incomes earned by households. They create incomes for the domestic firms. On the other hand if value of imports exceeds value of exports of a country, trade deficit occurs. In this case, the government reduces the public debt and supplies funds to the capital market which are received by firms.
Balanced Budget Multiplier : Till now we have discussed the change produced in national income due to government expenditure and taxes separately, while keeping the other variable at constant. This is a basic identity in national income accounts which needs to be carefully understood. This the equilibrium point at which the national income is determined that is Rs. On the other hand, the business sector exports goods to foreign countries and its receipts are an injection in the circular flow. Total expenditure flow in the economy is now the sum of consumption expenditure denoted by C , investment expenditure I and Government expenditure denoted by G. Similarly, according to the concept of saving and investment, the new investment curve I+G intersect the saving curve 5 at point in Panel B. Saving-Investment Identity in National Income Accounts in a Two Sector Economy : Despite the fact that people who save are different from the business firms which primarily invest, in national income accounts savings are identical or always equal to investment in a simple two sector economy having no roles of Government and foreign trade.
Investment relates to net investment after deducting depreciation. The government borrowing through its effect on the rate of interest affects the behaviour of firms and households. On the other hand, investment means some money is spent on buying new capital goods to expand production capacity. Here the aggregate demand is Y 1E 1 and the aggregate output is Y 1a. It is the process which enables entrepreneurs to innovate better manufacturing processes and improve the quality of services offered in the economy. However, in national income accounts we are concerned with actual saving and actual investment.
The circular flow has another leakage in the form of Taxation T from households and an injection of Government Expenditure G into firms. Importance of Fiscal Policy: The circular flow of income and expenditure points toward the importance of fiscal policy. Two-Sector Model: A two-sector model of income determination of an economy consists only of domestic and business sectors. Equality of Aggregate Demand and Aggregate Supply : The equilibrium level of national income is determined at a point where the aggregate demand function curve intersects the aggregate supply function. Government borrowing increases the demand for credit which causes rate of interest to rise.
Businesses can also contribute by establishing for-profit businesses that bring people to natural areas. However, improved technology and the growth of other energy sources has seen a dramatic decline in this primary sector industry. Using the organization list in Sector Circles Handout Two , the student groups write the names of organizations in the correct sector circle on a Venn diagram. We further assume that there are no inter-households borrowings. It was believed by classical economists that financial market provides a mechanism which coordinates the savings of households and the investment expenditure, by the firms. Generally, exports and imports are not equal to each other.
The final link in the process — the sale of manufactured clothes. Figure 2 shows how the circular flow of income and expenditure is altered by the inclusion of saving and investment. By using its budget therefore the government can influence the levels of income, output and expenditure for the economy as a whole. Now, let us analyze the effect of balanced budget and proportional income tax simultaneously on national income. The consumption function is shown by the slope of the C curve in Fig. Government policy which influences the level of spending in the economy.
These add to the money flows which are shown in Fig. To conclude, the circular flow of income possesses much theoretical and practical significance in an economy. Circular Income Flow in a Two Sector Economy: Real flows of resources, goods and services have been shown in Fig. In fact we have explained above the flow of money that occurs in the functioning of a closed economy with no savings and no role of government. Quinary sector The quinary sector is the part of the economy where the top-level decisions are made. The excess of intended investment over intended saving means that aggregate demand is greater than aggregate supply by eE 1.
In opposite direction to this, money flows from business firms to the households as factor payments such as wages, rent, interest and profits. It is a two-sector economy where only consumption and investment expenditures take place. As a result, circular flow of income does not continue at a steady level in a free-enterprise capitalist economy unless certain corrective and preventive steps are taken by the government to maintain stability in the economy. Government Expenditure : First, we take government expenditure. But businessmen intend to invest bE, to buy investment goods. Once students have completed the assignment, have them describe where they placed the different groups and why. This article includes a , but its sources remain unclear because it has insufficient.