Question

Explain the circular flow of modern economic growth (include diagram).

Answer 1

The circular flow of economic growth shows the relationship between various elements of the market economy.

The first element or institution is household . Households tend to buy good and services and are the net savers in the economy. The main aim of the households is to satisfy the unlimited needs with budget constraints. Also they are the owners of the factors of production like land , labour , capital , entrepreneurship which they provide to firms and receive rent, wages , interest and profit.

The next elememt which is the net borrowers borrow money from households and carry the production process . The main aim of the firms is to produce goods and service in order to satisfy the needs and wants of the households. They are mainly concerned about the profit maximisation objective.

The next element is government which establishes property rights and keeps an eye on the other elements of the economy.

The last element is foreign sector which facilitates imports and exports in the economy. Note that in this case we are considering the four sector model of economic growth ie the model which includes housholds, firms , government and foreign sector.

The model above is the circular flow of economic growth where the elements of the economy are shown ie households , foreign sector , business and government sector . Various transactions are taking place between these sectors of the economy.

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