Question

Consider the hypothetical example of Dominion Island that has firms producing only two goods, gold and cotton, the proceeds of which it uses to purchase other goods and services from neighbouring islands through its banks. Assuming that all other required institutions in an economy are prevalent in this island, discuss the circular flow of income and spending in Dominion Island. No diagram is required.

Answer 1

Answer:
As all other domestic institutions in an economy are prevalent in the island, circular flow of income and spending in Dominion Island is as mentioned below:

• As all purchase of goods other than cotton and gold is being done only Via banks, the bank can issue virtual credits or paper form of credit for the amount of cotton and Gold that a person can submit to the bank.
• That virtual credit can be used by everyone in the island to purchase any other goods.
• Even from the bank we can submit the virtual credit that we get by selling cotton and Gold to the bank purchase other commodity which bank purchase from outside by giving them gold and cotton, which can be sold to all the persons in the island as the cost of Virtual creditor paper credit provided by the bank.
• So flow of income and commodity is happening via Virtual credit which is handy and available with everyone.
• Even employer can pay their employees or for their services in the form of Virtual crerdit which they can use to purchase food and other necessity.
• Referencing is always done between gold and this virtual credit to maintain balance in the economy, and their fluctuations can bring inflation in the island economy.
• balance of trade in this island will be calculated based on amount of export minus amount of import, if import is more than export then there is trade deficit in the island. On the other hand if export is more than import than its trade surplus.
• With the passage of time, island will be able to create secondary goods as well from the goods they are importing from neighbour islands, decreasing their dependency on just Gold and Cotton to export. Similar situation is happening with Arabian oil rich countries as well.

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