Ma c r o

Ec o no mic s
Th e M o d e l o f th e
Cir c u la r Flo w o f
In c o m e :
Pe r spe c t i v e i n
Ba n g l a d e sh .

Submitted By: Submitted to:

Group No-2 Md. Omar Faruque

2nd
nd
Year, 1st Semester Lecturer, Department of Finance

Jagannath University, Dhaka.

Date of Submission: 18th November, 2009

 GROUP - 02

Names of Members

Serial Roll No. Name of the student

No.
1 07882757 MD. AREFIN DEWAN
2 702 IMRAN HOSSAIN
3 658 API PODDER
4 796 OHASIUR RAHMAN
5 751 SAIRA BEGUM
6 676 LUTFUN NAHAR LUBNA
7 692 FAHMIDA MUNNI
8 735 NOAB SIKDER
9 750 SHAHIDUL ISLAM
 The Model of Circular Flow of
Income: perspective in Bangladesh.

Abstract:
Macro economics is necessary for a country for its business,
government agencies and economy. THE CIRCULAR FLOW OF
INCOME is an important section of macro economics. Bangladesh is
a developing country. So we can change our economic condition by
using properly the circular flow of income method.The measurement
of income and prices is the first step of it. This analysis shows the
impact of CIRCULAR FLOW OF INCOME.

Introduction:
In economy households own all the economic resources. These resources
are two types that are business firm and households. Firms rent the use
of these resources to carry out the production of final goods and services
which are sold to the household.

The model of circular flow of income explains the real output (GNP) and
the price level. Unemployment is highly related to the parallel
movements of the gap between actual and natural real GNP.
Unemployment is the main problem in our country. To solve this
problem, the knowledge about the circular flow of income is more
important.
OBJECTIVE:
The objective of the paper implies:

 A clear concept about The Circular Flow of Income AND ITS IMPACT
ON ECONOMY OF BANGLADESH.

 To describe the various aspects of the model which is influence it.

 And how the country is benefitted by this model.

SOURCE OF DATA:

All the collected data are secondary type. We the group consisting nine
members contribute for collecting data from many website such as

www.cpd.org.bd, www.bdresearch.org, www.worldbank.org,

www.thefinancialexpress-bd.com, www.imf.org, www.globalissues.org,

We also collected data from Bangladesh Institute of Development Studies
(BIDS) and some economic journals.

Limitation of the Study

As the collected data all are secondary type so its may not correct all. We
just work only some related sector of economic recession which may affect in
near future, if we working with more sectors then the study will more reliable
and gives us a brief idea about total economy of Bangladesh.

METHODOLOGY:
We collected some information from the web page but there we feel the
need of additional data from the Daily newspaper and journals also which are
not available in website.
 List of Abbreviations and Acronyms:

BB Bangladesh Bank
BDT Bangladeshi Taka

BEA Bureau of Economic Analysis

BGMEA Bangladesh Garment Manufacturers and Exporters Association
CPD Centre for Policy Dialogue

CPI Consumer Price Inflation

EPB Export Promotion Bureau
EU European Union
FY Financial Year
GDP Gross Domestic Product
GNP Gross National Product
GEP Global Economic Prospects
IMF International Monetary Fund
MOF Ministry Of Finance
NABE National Association for Business Economics
NI National Income
NIPA National Income and Product Accounts
NBR National Board of Revenue
NNI Net National Income

RMG Readymade Garment

Literature view:
According to M.L. Jhingan,
“The circular flow of income and expenditure refers to the process
whereby the national income and expenditure of an economy flow in a
circular manner continuously through time.”
According to Ackley.
The circular flow usually shows two entities. One called “business”
the other “households”. Households purchase the entire product of
business, giving to business in payment a flow of money receipts precisely
equal to the flow of money payments that business makes to households.
According to Dornbusch and Fischer,
“circular flow is the flow of income that shows the value of output is equal
to the value of incomes received in the economy.’’
According to W. H. BRANSON,
“circular flow of income is the flow of product and income in a simple
two-sector economy with only households and firms. This measure the
flow of output by the total expenditures by households on that flow.”

According to Simon Kuznets,

“The circular flow of income is a simple model of the economy showing
flows of goods and services and factors of production between firms and
households.”

According to ROBERT J. GORDON,

“In the absence of government and international trade this simple model
shows that households provide the factors of production for firms who
produce goods and services.”
Definition Circular Flow of Income:

A model that indicates how money moves throughout an economy,

between businesses and individuals. Investors spend their income by
consuming goods and services from businesses, paying taxes and investing
in the stock market. Businesses use the money spent by individuals while
consuming and the money raised from selling stock to pay for capital to
run their business, purchase material to manufacture products and to pay
employees. All expenditures from individuals become the income of the
businesses, and the expenditures of the businesses become the income of
the individuals.

Fig: The basic circular flow of income model.

The basic circular flow of income
model consists of six assumptions:
The economy consists of two sectors: households
and firms.

Fig: The circular flow of income model.

Households spend all of their income (Y) on goods

and services or consumption (C). There is no saving
(S).
All output (O) produced by firms is purchased by
households through their expenditure (E).
There is no financial sector.
There is no government sector.
There is no overseas sector.
The transactions that should be included in income and
expenditure:
There are three major requirements in the rule for including items in
the total final product, or GNP.
“Final product consists of all currently produced goods and
services that are sold through the market but not resold.”

Currently produced:
The first part of the rule- to be included in final product a good must
be currently produced- obviously excludes sales of any used items such as
houses and cars, since they are not currently produced.

Sold on the market:

The second part of the rule- goods included in the final product must
be sold on the market and are valued at market prices. It means that we
measure the value of final product by the market prices that people are
willing to pay for goods and services.

But not resold:

The third part of the rule to be included in final product a good must
not be resold in the current market- further limit of the acceptability of
items. The many different goods and services produced in the economy are
used in two ways. Some goods are used like as a intermediate goods. And
the opposite of an intermediate good is a final good.

Investment and savings:

Types of investment: Final goods that business firms keep for
themselves are called “ private investment” or private capital information.
The private investment is of two kinds. Such as,
Inventory investment:
Bread purchased by the grocer but not resold to consumer in the
current period stays on the shelves, raising the inventory level. The terms
inventory investment means that, if the business firms invested money to
increase their inventory level at current period then it is called inventory
investment.

Fixed investment:
This includes all final goods purchased by business firms other than
addition to inventory intended for eventual resale. The main types of fixed
investment are structures (factories, office buildings, apartments, houses)
and equipments (cash register, computers, trucks ).

Relation of investment and saving:

The portion of household income that is not consumed is called
personal saving. The portion of saving of household is channeled to
business firms through-
1. Household buy bonds and stocks issued by the firms, and the firms then
use the money to buy investment goods.
2. Households save the income in bank and the bank lend the money to
business firms to buy investment goods.
Weather household channel their saving to firms directly or indirectly. So
the total income is equal to total expenditure. This conclusion follows from
the definitions of three concepts just introduced.
Income (Q) = expenditure (E)
Expenditure (E) = consumption (C) + investment (I)
Saving (S) = income (I) – consumption (C)
Symbolically the equations are as follows,
Q=E
E=C+I
S = Q – C or rearranging, Q = C +S
Now we can see why saving and investment are must be equal. By
rearranging the above equation we get,
C+S=C+I
Or, S = C – C + I
Or, S = I
Since income is equal to expenditure, the portion of income not consumed
(saving) must be equal to the non-consumption portion of expenditure
(investment).

Investment versus consumption:

To distinguish between consumption and investment one reason is
that expenditure plans for the two are made by different economic units.
Households decide how much of their incomes they want to consume and
save; business firms decide how much they want to invest.
A second reason for distinguishing between consumption and investment
is the different implications of the two types of spending for the
economy’s potential to produce output in the future. An economy that
consumes a small portion of its income has a large portion left over for
saving and investment, that is for the formation of capital assets. It can
build a relatively large number of factories, office buildings, computers, or
other business equipment, and those capital assets add to nation’s real
GNP for next year and the years to follow.
Net exports and foreign exchange rate:
Exports are expenditures for goods and services produced in a
country sent to other countries. Such expenditures create income for the
country.
Imports are expenditures for goods and services produced elsewhere,
which thus do not create domestic income. The difference between exports
and imports, net exports is a component of final product and GNP.
Net exports can also be net foreign investment and given the same
economic interpretation as domestic investment. Because both domestic
and foreign investment are components of domestic production and
income created.
The quantity of exports and imports depends partly on the foreign
exchange rate of the dollar relative to other currencies. When dollar prices
strengthens or appreciates, in terms of other currencies then the exports
rate declines and raise imports and hence to cut net exports (a components
of GNP).Conversely, a depreciation of the dollar raises the net exports and
cut imports for the country.

The government sector or five-sector circular flow model:

The five-sector circular flow model describes the operation of the
economy and the linkages between the main sectors in the economy. The
five-sector model is based on dividing the economy into five sectors. A
sector may be defined as a part of the economy where the participants are
engaged in a similar type of economy activity.
1. Individuals
2. Businesses
3. Financial institutions
4. Government
5. International Trade
 Fig: The five sector circular flow model.
Individuals
􀂃 This sector consists of all individuals in the economy.
􀂃 These individuals are the owners of productive resources, and the consumers
in our economy.
􀂃 Individuals supply factors of production (inputs) such as labour and
enterprise to businesses, which they use to produce goods and services.

Businesses
􀂃 This sector consists of all the business firms engaged in the production and
distribution of goods and services (apart from financial services).
􀂃 It concerns all their activities involved with buying factors of production and
using them to produce and sell goods and services.
􀂃 Individuals and businesses are interdependent.
 Fig: The circular flow of Government sector.
Financial Institutions
􀂃 This sector consists of all those institutions that are engaged in the
borrowing and lending of money, acting as the intermediaries between
those who save, and borrowers of money.
􀂃 Financial institutions are needed for individuals and firms to be able to
undertake saving and investment.
􀂃 Savings: leakage; Investment: injection
Government
􀂃 In Australia, this sector consists of the Commonwealth, State and local
governments.
􀂃 It is involved in the satisfaction of collection (community) wants.
􀂃 It obtains the resources to do this through imposing taxes on the other sectors
of the
Economy
􀂃 It uses this tax revenue to undertake various government expenditures.
The circular flow of income in Economy of Bangladesh:

The economic outlook of Bangladesh:

GDP Growth:

Preliminary estimates prepared by Bangladesh Bureau of Statistics

(BBS) reports that, GDP is expected to post a growth of 5.88 per cent
during FY2008-09. If this be actually the case, it would be the lowest GDP
growth over the last five years and will be considerably less (0.62
per cent) than the targeted growth of 6.5 per cent for FY2008-09.
GDP - real growth rate: 4.9% (2008 est.)
6.2% (2007 est.)
6.4% (2006 est.)

Year GDP - real growth rate Rank Percent Change Date of Information
2003 4.40 % 51   2002 est.
2004 5.30 % 48 20.45 % 2003 est.
2005 4.90 % 84 -7.55 % 2004 est.
2006 6.40 % 50 30.61 % 2005 est.
2007 6.60 % 58 3.13 % 2006 est.
2008 6.30 % 67 -4.55 % 2007 est.
2009 4.90 % 85 -22.22 % 2008 est.

However, in view of the ongoing global recession and in the context of

uncertainties in domestic economy in the backdrop of high inflation during
the early months of FY2008-09, low investors’ confidence
and change of government in January 2009, this growth rate ought to be
considered as respectable.
As a matter of fact, adverse factors that which informed macroeconomic
performance in FY2008-09 led to considerably lower GDP growth
projections of around five
per cent or even lower by many quarters, including the World Bank (WB),
the International Monetary Fund (IMF) and the Asian Development Bank
(ADB).

Sources of Growth:

Despite the notably robust performance of country’s agriculture

sector, overall, tangible sectors of the economy1 posted a moderate growth
of 5.38 per cent while intangible sectors recorded a growth of 6.20 per
cent.
It is to be noted that the targeted industrial growth of 11.70 per cent in
FY2008-09 was significantly higher than the actual growth of 6.78 per
cent in FY2007-08.

Government Earning:

In Bangladesh, the major chunk of Government earnings comes

through the National Board of Revenue (NBR). The components of the tax
earnings of NBR are taxes on income and profit, VAT, customs duty and
supplementary duty.

The Figure shows the targeted resource allocation from different

departments including foreign grants, loans, domestic financing, non-tax
revenue, tax revenue (non- NBR) and tax-revenue from NBR for the year
2008-09.

Savings:

Stagnating share of domestic savings in the GDP continued to remain

unchanged in FY2008-09; rather domestic savings as a percentage of GDP
in Bangladesh somewhat declined from 20.31 per cent in FY2007-08 to
20.02 per cent in FY2008-09 (Figure 3). Rising prices of essential items in
the first half of FY2008-09, particularly for food items, was perhaps also a
contributing factor.

Investment:

In absolute terms, Gross capital formation in FY2008-09 would be

Tk. 148,840 crore in nominal terms (Tk. 92,002 crore at constant prices).
Growth of gross capital formation made some progress, posting 5.72 per
cent in FY2008-09 compared to only 1.80 per cent in FY2007-08.
However, this is lower than the general trend which hovers between eight
to nine per cent. Investment has suffered from both lack of infrastructure
and continuing uncertainty in recent times.
Trend and Pattern of Economic Growth in
Bangladesh:
Bangladesh experienced an unstable and low average growth rate of
real GDP during the 1970s and 1980s. The average growth rate of GDP
during the 1980s was 3.7 percent. However, since the early 1990s, the
growth rate has been experiencing an increasing trend with some year-to-
year fluctuations. The average growth rate in the 1990s was 4.8 percent,
which increased further to 5.6 percent during 2001 and 2006 (Figure 3.1).
Current flow of income:
The current flow of income is given below:

Table 2.2 shows the growth rate of recent year

Recommendation:
The earlier discussion confirms the idea that circular flow of income
has immense influence to the economy of our country. For achieving the
best possible result of this model we can offer some recommendations.

These are follows:

 Imports are a leakage out of the circular flow of income. to stop this
leakage, government should adopt appropriate measures so as to
increase export and decrease imports.

 Sometimes one goods can be double counted, which impact on

National Income is. So Govt. should careful of it.

 The model of circular flow of income depends on NI. So NI should

calculate accurately.

 Depreciation cost should be deducted in the time of measuring NI.

 The taxes of various sources in Bangladesh should collect properly.

That no one can escape from tax.

 Corruption must be control in Govt. sector. As soon as possible.

 The mechanism of market should develop by the Govt. of

Bangladesh.

 The export income and import expenditure should calculate correctly.

 The rate of changes of price level can identify accurately.

Conclusion:
The concept of the circular flow of income gives a clear idea of the
economy. We can know whether the economy is working efficiently or
whether there is any disturbance in its smooth functioning.

The role of leakage enables us to study their effects on the national

income. On the other hand, consumption expenditures are inflows. It
leakage exceed inflows, total spending is smaller than output it inflows
exceed leakage; the spending stream is enlarged in the circular flow.

It’s with the help of circular flow that the problems of disequilibrium
can be studied, As well as the economic situation of Bangladesh
.
The study of circular flow also highlights the importance of monetary
policy to learning about the quality of saving and investment.

As a third world country, Bangladesh must follow this model to

immense change in total economy of the country. It will be very helpful
for our economic and social development. The Government should
concern about the recommendation given by us in previous page.
References:
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2. Macro economics theory by EUGERE A DIULIO (Page-12)

3. Intermediate macro-economics by MICHAEL R. DARBY (Page 16)

4. Macro-economics by RUDIGER, DORNBUSCH, STANLEY FISHER, RICHAR

STARTZ, 9TH edition (page, 30).

5. Macro-economics by DUNEAN M, MC DOUGALL and THOMAS F.

DERNBURG, 2ND edition, page, 23.

6. Economics by SAMUELSON and NORDHAUS, 18TH edition, page 425.

7. Macro economics by ROBERT J. GORDON, 3RD edition, page 32.

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9. Aggregate economics and public policy by BARRY N. SIEGEL, 3RD edition,

chapter 1.

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edition, page 16.
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Economic Association, Dhaka.
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