Question

Discuss the simple circular flow of income.

Answer 1

The circular income flow is a way of representing money flows between the two main groups in society-producers (companies) and consumers (households). Such flows form part of the essential cycle of fulfilling human desires. The free market economy, as they are called, consists of two components, or sectors. Those are households and firms. Housing people work for companies and receive salaries in exchange. This is defined as national income on the scale of the economy as a whole-the total amount of revenue collected for a given period of time. This money is spent on food , clothing , transportation, entertainment, etc, and so it comes back to the companies. The circular flow is this.

The circular flow model starts with the household sector participating in consumption (C) spending and the business sector manufacturing the goods.

The circular flow of revenue, the government sector and the foreign trade sector should also involve two more industries. The government injects money into the circle through government spending (G) on such programs as the administration of social security and national parks. Exports (X), which carry in cash from international buyers, often flow capital into the circle.

Furthermore, enterprises which invest (I) money to buy capital stocks contribute to the flow of money into the economy.

Just as money is being pumped into the economy, it is being removed or leaked by different means. Government-imposed taxes (T) reduce the flow of income. Another diversion is money paid to foreign companies for imports (M). Savings (S) by businesses that otherwise would have been put to use are a decrease in the circular flow of an economy’s income. A government calculates its gross national income by tracking all of those injections into and withdrawals from the circular income flow.