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

The circular revenue flows in the economy show mutual resource exchange between various economic sectors such as households, firms, the government, the commodities market, the labor market, the financial market and the foreign market.

Gold and cotton are produced by companies on Dominion Island with the aid of labor from the labor market (to extract gold or to grow cotton). It can also use other production factors such as land and capital. It pays workers wages and pays for capital and land, uses sales revenue and keeps the surplus as a profit. The workers and the owners of the company act as consumers because they are families. They spend wages and profits on products produced by domestic companies (gold and cotton) and on items imported from outside the country. In addition, they will save certain income as financial market flows as well as loan from them to finance their consumption and investment as a flow outside financial markets. The investment returns to gold and cotton production, of which some are sold domestically and the remainder exported. The households and companies also pay taxes to finance their expenses. The government also has government savings in the financial (banks) flow while it has financial (bank) deficits. The circular flow of income in the economy occurs in this way.