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Unit 1 Circular Flow

The circular flow model illustrates the movement of money, goods, and services between different sectors in an economy, highlighting the interdependence of households, businesses, government, foreign, and financial sectors. It serves as a fundamental concept in macroeconomics, aiding in the measurement of national income and understanding economic activities. The model emphasizes the balance between injections and leakages, impacting national income growth or decline.

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6 views

Unit 1 Circular Flow

The circular flow model illustrates the movement of money, goods, and services between different sectors in an economy, highlighting the interdependence of households, businesses, government, foreign, and financial sectors. It serves as a fundamental concept in macroeconomics, aiding in the measurement of national income and understanding economic activities. The model emphasizes the balance between injections and leakages, impacting national income growth or decline.

Uploaded by

dlukwanalinamandla
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Circular Flow

Prepared by Mr Qoyi
After this lesson you
be able to
understand:
The definition of
Circular Flow

Learning Understand the


Outcomes circular flow model

Circular flow with


sectors

Implication of the
circular flow
What is • The circular flow model is an economic model
that presents how money, goods, and services
Circular move between sectors in an economic system.
• The flows of money between the sectors are
flow? also tracked to measure a country’s national
income or GDP, so the model is also known as
the circular flow of income
• The idea of circular flow was first introduced by
economist Richard Cantillon in the 18th century and then
progressively developed by Quesnay, Marx, Keynes, and
many other economists.
• It is one of the most basic concepts in macroeconomics
.
Understandin • How an economy runs can be simplified as two cycles
flowing in opposite directions.
g the Circular • One is goods and services flowing from businesses to
Flow Model individuals, and individuals provide resources for
production (labor force) back to the businesses.
• In the other direction, money flows from individuals to
businesses as consumer expenditures on goods and
services and flows back to individuals as personal
income (wages, dividends, etc.) for the labor force
provided.
• This is the most basic circular flow model of an
economy. In reality, there are more parties participating
in a more complex structure of circular flows
Circular • Two-Sector Model
Flow • The model described above is the two-sector
model, which is the most basic model
Models containing only two sectors: individuals or
households and businesses.
with • In the two-sector model, it is assumed that
Sectors households spend all their incomes as
consumer expenditures and purchase the
goods and services produced by businesses.
• Thus, there are no taxes, savings, or
investments that are associated with other
sectors.
• Three-Sector Model
• In the three-sector model, the government is
added to the two-sector model.
• In this model, money flows from households
and businesses to the government in the form
of taxes.
• The government pays back in the form of
government expenditures through subsidies,
benefit programs, public services, etc.
• Four-Sector Model
• The four-sector model contains the foreign
sector, which is also known as the overseas
sector or external sector.
• The overseas sector turns a closed economy
into an open economy.
• It is connected to the other sectors through
two flows of money: foreign trade (imports and
exports) and foreign exchange (inflow and
outflow of capital).
• Like the other sectors, each flow of money is
paired with a flow of a factor of production or
goods and services.
• Five-Sector Model
• The fifth sector – the financial sector – is added
to complete the circular flow model.
• It includes banks and other institutions that
provide borrowing and lending services to the
other sectors.
• Savings and investments are assumed in the
five-sector model, which flow from other
sectors with residual cash into the financial
institutions, then out to the sectors that need
money.
• As long as lending (injection) is equal to
borrowing (leakage), the circular flow reaches
an equilibrium and can continue forever.
• As a fundamental concept of macroeconomics,
the circular flow model has been widely applied
Implication in different studies, with significant impacts on
s of the the understanding of economics.
• Four examples are listed below to show the
Circular significance of the model.

Flow Model • Measurement of national income: The


sectors in the circular flow model are the
components of the calculation of national
income.
• The expenditure approach calculates a nation’s
GDP as the sum of the household consumption
expenditures, private domestic investment,
government consumption and investment
expenditures, and net exports (GDP = C + I + G
+ [X-M]).
• Knowledge of interdependence: The
circular flow model underpins the knowledge of
interdependence between sectors in an
economic system.
• The activities and money flows cannot take
place without interaction with another sector.
• Unending nature of economic
activities: Money and economic resources flow
in cycles indefinitely with an equilibrium of
aggregate income and expenditures.
• Injections and leakages: The circular flow of
an economy is balanced when the total
injections equal the leakages. If injections
overweight leakages, the country’s national
income will grow. If injections are below
leakages, the national income will decrease.
• The circular flow model, also known as the
circular flow of income, describes how money
and economic resources flow in cycles between
different sectors in an economic system.
• In the basic (two-factor) circular flow model,
money flows from households to businesses as
consumer expenditures in exchange for goods
and services produced by the businesses, then
Summary flows back from businesses to households for
the labor that individuals provide.
• The five-sector model consists of (i) households
(the public sector), (ii) businesses, (iii)
government, (iv) the foreign sector, and (v) the
financial sector.
CIRCULAR
FLOW
DIAGRAM
THANK YOU
END OF THE LESSON

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