Economic Circular Flow Model
The Economic Circle Flow Model is a way to explain the way that money and resources are used in an economy. The model includes three sectors: the Real flow, the Money flow, and the Government sector. Let’s look at each of these in turn.
You’ll also learn about the Three-Sector Model. What is it and how can it help you understand the circular flow of money and resources? What are the consequences of this model?
Three-sector model
A three-sector economic cycle is a closed system of money flows between public and private sectors. The government buys products and services from the private sector and uses the money to create transfer payments and other welfare programs.
Government expenditures also inject into the circular flow, as they are taxed and spent by consumers and businesses. But these injections are only partially accounted for by the three-sector economic model.
Consider the example of a Nutella factory. Here, the household sector exports labor and capital and pays businesses for goods and services.
This circular flow of money continues over time, even as the economy goes through booms and recessions. Its workers and landowners will receive wages and rent for their labor and investments, and its logistics team will be paid to deliver the finished product to consumers.
In this model, all these activities and transactions are beneficial to both the household and the business sectors.
Real flow
The Economic Circular Flow Model (ECFM) illustrates how money flows into and out of the economy. Injections are amounts of money that enter the economy from the private sector or from the government.
Leakages are amounts of money that leave the economy through other means, such as saving and investment. In addition to injections, the economy also experiences leakages through taxation and other sources.
Leakages are most often associated with the government sector, which injects money into the economy through taxes and other means. This money is then injected back into the economy through various activities, including exports and saving.
Real flow in the economic circular flow model begins with a market for goods and services. People spend their income on these products. As goods and services are produced, they become revenue for businesses.
Meanwhile, money payments flow from households to businesses. But in a more complex circular flow model, more people participate in the economy. A circular flow model shows that all of these interactions are mutually beneficial for society. Ultimately, it shows that economic systems can be viewed as a system of cycles.
Money flow
The circular flow model of the economy shows how different sectors of the economy are linked by real and money flows.
Producers need the income and commodities produced by households, while the latter need to spend this money. As a result, the flow of money between sectors is circular, as is the flow of labour. Ultimately, the whole economy is affected by both real and money flows.
A circular flow model can help explain the workings of the economy and help us understand what is going on in the world today.
The circular flow model also shows how money is injected into and exits the economy. It also illustrates a key concept, leakages and injections.
Leakages occur when a sector withdraws money from the economy without spending it. Injections, on the other hand, occur when funds are added to the circular flow.
The government sector contributes to leakages by collecting taxes, which lowers household spending on goods. Consequently, government expenditure provides public goods and welfare payments to the community.
Government sector
An Economic circular flow model for government sector has the following structure: the government collects revenue from households and firms through taxes, and then diverts that money to the public sector.
Tax revenues reduce the current expenditure of households and businesses, and government spending generates welfare payments and collective services for the community. These transfers are called leakages, and include income taxes, government spending, and other forms of redistribution of income.
The economy is composed of two main sectors: the household and the business. In the household sector, savings are invested by individuals and businesses.
Foreign trade creates injections of cash, and investments by businesses contribute to the circular flow of money.
The government sector also receives a share of money flowing in the economy through taxes. But the most difficult part of the model is the foreign sector. It involves global transactions, which makes it more complex to study.
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