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 neighboring 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 Dominion island is not self reliant, it need to trade its commodity with neighbouring island to do day to day activities. 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.
• 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.
• 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.
• With the passage of time, island will be able to create secondary goods as well from the goods they are importing from neighbouring island, decreasing their dependency on just Gold and Cotton to export.
• Banking system will be one of the biggest backbone to run Dominion island, so its functioning will be fair and unbiased and should be open in public to function properly.