Circular Flow in Economics

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Analysing the economic relationship between households and firms The household is the basic unit of analysis in many social, microeconomic and government models. The term refers to all individuals who live in the same dwelling. In economics, a household is a person or a group of people living in the same residence. Household are owners of the factors of production which is includes land, labor, capital and entrepreneurship. Which are made available to firm that will pay factor incomes to the households. The firm will use the factors of production to produce output in the form of goods and services, which will purchase by the households. In buying the goods and services, households therefore incur expenditures. 2.0 Circular Flow between Firm and Households

The circular flows between firms and household may therefore be represented by the following 4 flows: Flow of factor of production from household to firms
Flow of incomes from firm to household
Flow of output of goods and services from firm to households Flow of expenditures from household to firm
These four flows are illustrated as appendix 1. Outer flow of incomes and expenditures are flow of money, whereas the inner flows of factors of production and outputs are flows of goods and services. According to Google 2011 the basic circular flow of income model consists of seven assumptions it include the economy consists of two households and firms sectors, households spend all of their income on goods and services or consumption. There is no saving and all output produced by firms is purchased by households through their expenditure, there is no financial, government, overseas sector. Last it is a closed economy with no exports or imports. Withdrawals occur when there are movements of funds out of the circular flow of income. 3.1 Saving (S)

Households may not speed all the factors income received on current consumption, preferring to keep some for later deferred consumption. The first is the Financial Sector that consists of banks and non-bank intermediaries who engage in the borrowing (savings from households) and lending of money. In terms of the circular flow of income model the withdrawals that financial institutions provide in the economy is the option for households to save their money. This is a withdrawal because the saved money cannot be spent in the economy and thus is an idle asset that means not all output will be purchased. 3.2 Taxation (T)

The next sector introduced into the circular flow of income is the Government Sector that consists of the economic activities of local, state and federal governments. The withdrawal that the Government sector provides is through the collection of revenue through Taxes (T) that is provided by households and firms to the government. A tax is not a voluntary payment or donation, but an enforced contribution, exacted pursuant to legislative authority and is any contribution imposed by government. For example income tax is compulsory charge by the government to the people who is salary RM3000 and above for a month. 3.3 Import (M)

Households may prefer to purchase goods and services from abroad instead of consuming domestically produced goods and services. In the circular flow of income model is the overseas sector which transforms the model from a closed economy to an open economy. The main withdrawal from this sector are imports (M), which represent spending by residents into the rest of the world. There are two basic types of import which is include industrial and consumer good, intermediate goods and service. For example we will import the apple for other country which is not suitable plant in our country. Injections occur when there are movements of funds into circular flow of income. 3.4 Investment (I)

The injection that the financial sector provides into the economy is investment (I) into the business or firms sector. The household will save some of their income for the investment. An example of a group in the...
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