Question

Write a short paragraph of approximately 200 words on the following topic:

Circular Flow of Income

The circular flow of income diagram shows the linkage among stakeholders such as households, business firms, the government, and financial markets. Explain how your household interacts with other stakeholders in the economy and helps keep the wheel of the economy turning.

Answer 1

What Is the Circular Flow Model?

The circular flow model demonstrates how money moves through society. Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money.thats the basic form of the model, but actual money flows are more complicated. Economists have added in more factors to better depict complex modern economies.These actors are the components of a nation's gross national product (GDP) or national income. For that reason, the model is also referred to as the circular flow of income .In everyday life we experience the circular flow of income between households and firms. If we buy an item in the shop we are doing the circular flow between households and firms. It is important to us to know how the circular flow works. We can control our spending and can save as much as we can if we fully understand the circular flow. In macroeconomics it stated there that the terms circular flow refers to a straightforward economic form which portrays the mutual circulation of income between manufacturer and patrons. In the circular flow model, the mutually supporting entities of manufacturer and buyer are referred to as “firms” and “households” correspondingly and supply each other with aspects in order to ease the flow of income. The households are the one who owns the factors of production (FOP) while the firms are the one who uses the factors of production such as land, labour, entrepreneurship and capital. By the factors of production the firms will pay the factors of income to the households. Such as in land the firm will pay rent, in labour the firm will pay wages, in entrepreneurship the firm will pay profits and in capital the firm will pay interest.The spending by households on goods and services is funded by the income that households earn. But this income comes from firms, and they get their income from the spending of households. Thus there is a circular flow of income in an economy as a whole.Governments levy taxes on households and businesses in order to provide certain benefits to everyone. In the circular flow model, injections into the economy include investment, government purchases, and exports while leakages include savings, taxes, and imports.The income the government receives flows to firms and households in the form of subsidies, transfers, and purchases of goods and services. Every payment has a corresponding receipt; that is, every flow of money has a corresponding flow of goods in the opposite direction.In the financial sector. In terms of the circular flow of income model, the leakage that financial institutions provide in the economy is the option for households to save their money. This is a leakage because it is a leakage out of the current income thus reducing the expenditure on current goods and services.