Question

In: Economics

Can you explain whether Circular Flow Model captures the federal government? Without transfer payments do you...

Can you explain whether Circular Flow Model captures the federal government? Without transfer payments do you believe our country’s money supply would increase or decrease? Please explain. Can you identify at least 4 examples of transfer payments? Does the Circular Flow Model differ based on a Classical or Keynesian approach in Economics?

Solutions

Expert Solution

1. yes the Circular flow model captures the federal government. A circular flow model, in its most simple form, is an interaction between firms and households. The firm provides the households an income. The households use this income to buy the products the firm is making. This capital from households in return enables the firm to produce products.

But in its slightly more complicated form, the circular flow model also includes government (as it should, government is indeed involved in the economy in real life). The government takes taxes from the households and the firm. The government then provides social welfare to the households and also buys products of the firms. In intangible terms, the government also provides infrastructure, security etc.

Now in US, the Federal government levies a lot of different taxes such as income tax, corporate tax, excise tax etc. By virtue of these taxes, the federal government is captured by the circular flow model.

2. Transfer payments are the payments government does to an individual, without expecting any good or service in return. 4 examples of transfer payments are- Unemployment benefits, Pensions, Scholar grants and subsidies.

These result in an increased money supply as the person who gets the transfer payment would use it to purchase a good or service, resulting in increased money supply in the system.

3. Yes the model differs based on a Classical or Keynesian approach in Economics. In simple terms, the classical approach says that supply creates demand and those two reach an equilibrium without any government or external intervention. Classical model does not take government actions into account. Keynesian model on the other hand, argues that demand creates supply and that government should intervene and can affect the demand and supply factors.

Its now easy to see why the model will differ when used these approaches. If we use classical approach, the model only conerns itself with the firms and the households. If we take the Keynesian approach, the model also involves the government.


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