Project Circular Flow of Money

INTRODUCTION
Circular flow of income refers to cycle of generation of income in the production process, its distribution among
the factors of production and finally, its circulation from households to firm in the form of consumption
expenditure on goods and services produced by them.
Households are the owners of factors of production- land, labour, capital and entrepreneur. They supply the services
of these factors to those who make use of these services to produce goods and services.
Firms are the business concerns or the entrepreneurs who decide what, where, how and for whom to produce the
goods and services by using the services of factors of production which are supplied by households.
Supply of factors of production by households and demand for them by the firms determine prices of factor
services in the factor market. Factor prices in the form of rent, wages, interest and profits are paid by the firms and
received by the households. Such payments result in distribution of value of goods and services to the factor
owners.
Exchange of goods and services take place in the commodity market where they are sold by the firms and
purchased by the households. Money received by the households as factor income is spent in the commodity
market paying for the goods and services supplied by the firms.
•A closed economy is one that does not interact with other economies in the world.
•There are no exports, no imports, and no capital flows.
•An open economy is one that interacts freely with other economies around the world.
•An open economy interacts with other countries in two ways.
•It buys and sells goods and services in world product markets.
•It buys and sells capital assets in world financial markets.
WITH SAVINGS
AND
INVESTMENTS
II SECTOR
ECONOMY
WITHOUT
CLOSED
SAVINGS AND
ECONOMY
INVESTMENTS
III SECTOR
CIRCULAR FLOW ECONOMY
OF ECONOMY
IV SECTOR
OPEN ECONOMY
ECONOMY
TWO SECTOR ECONOMY
WITHOUT INVESTMENTS AND SAVINGS
ASSUMPTIONS:
• The economy consists of two sectors- households
& firms.
• Production takes place only in firms.
• Households are the consuming units.
• There is no financial sector i.e. no savings &
investments.
• There is no government operation, i.e. no taxes &
government expenditure.
• There is no foreign sector i.e. no imports &
exports.
• The two sector model of the circular flow of income (without savings &
investments) takes into account only two factors: households (consumers) and
businesses (firms).
• This is the model for a closed economy. Households have the factors of
production: Land, labour, capital and entrepreneurship. Firms use these factors of
production to produce goods and services. The households receive money in
exchange for the means of production. Rent for land, wages for labour, interest for
capital and entrepreneurship.
• On the other hand, households purchase the goods and services from the firms, for
which they pay to the firms. On one hand, money flows around and on the other
hand, there is a flow of goods and services. So the circle is round.
• It means entire income is used for consumption expenditure (Y = C).
TWO SECTOR ECONOMY
WITH INVESTMENTS AND SAVINGS
• The two sector model of the circular flow of income

(savings & investments) adds Financial Sector.
• Income is divided into consumption expenditure and
savings.
• Savings are done by households in financial sector/ market
which consists of commercial banks, stock market, non-
banking financial institutions etc. Money goes out of
circulation so it is a leakage.
• These savings in turn, are invested by financial market into
firms as Investments. Money comes back in circulation so it
is an injection.
• Thus, our equation becomes Y = C + I
CREATE WITH AN EXAMPLE CIRCULAR FLOW OF INCOME IN THREE AND FOUR SECTOR ECONOMY.
THREE SECTOR ECONOMY

• The three sector economy of the circular flow of income adds
government sector.
• Government plays an important role in the modern economy.
• Taxes are paid by households and firms to the government in the
form of direct an indirect
• Taxes. It reduces their disposable income so it is a leakage.
• These taxes are income for the government. Government spends it
both on households and
• Firms as government expenditure which is an injection.
• On households, government spends in the form of wages & salaries
and transfer payments.
• On firms, government spends in the form of subsidies &
government purchases.
• Thus, our equation becomes Y = C + I + G
FOUR SECTOR ECONOMY
• Imports of goods and services are done both by households
and firms. It is a payment done to foreign country and money
outflows from the economy therefore it is a leakage.
• Exports of goods and services are done both by households
and firms. It is a receipt from foreign country and money
inflows in the economy therefore it is an injection.
• Households export labour services and import goods. Firms
import & export goods & services.
• Net exports is taken which is exports minus imports.
• It can be positive (X > M) or negative (X < M)
• Thus, our equation becomes Y = C + I + G + (X -M)
CONCLUSION
• The basic purpose of the circular flow model is to understand how money moves within an economy. It breaks the economy
down into two primary players: households and corporations. It separates the markets that these participants operate in as
markets for goods and services and the markets for the factors of production.
• The prime conclusion of the circular flow model is that the overall volume of the circular flow is largely unaffected by the
path taken. In particular, household income can be used for consumption, saving, or taxes.
• Y=C+I+G+(X-M)
REFERENCES
www.wikipedia.com
https://www.yourarticlelibrary.com/macro-economics/circular-flow-of-income-in-a-four-sector-economy/30259
https://www.economicsdiscussion.net/circular-flow/circular-flow-of-income-2-sector-3-sector-and-4-sector-econom
y/10207
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INTRODUCTION

• The two sector model of the circular flow of income

THREE SECTOR ECONOMY

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