Economics Circular Flow

Topics: Inflation, Monetary policy, Macroeconomics Pages: 6 (1438 words) Published: March 13, 2011
The Economics of Business and Management

Assignment No. 3 & 4


Draw and label the circular flow model and use it to answer the following:


The circular flow can be explained very easily with a simple formula. GDP (gross domestic product) = C + I + G + X – Z=
= C + S +T – B
In here C is the consumption, I is investments, G – government spending, S – savings. On the other hand X is export, Z is imports T is for taxes and B is the benefits. The circulars flow shows the way how real recourses and payments flow between organizations/firms and households.

a) What is meant by leakages?
Leakages can be defined as a non-consumption use of income, which includes savings, taxes and imports. As it is shown on the circular flow the savings are connected with the household. On the other hand the households are in the same scheme with the firms and as a whole to the national income. The import coming from other countries goes to the consumer. And the taxes which are also closely connected to the national income scheme, serve the government needs.

b) What are withdrawals?

Withdrawals are part of the circular flow of the income, and closely connected with the injections. They are apart of the economy such as imports. If withdrawals are more than injections a current country will face a deficit and negative economic growth. If withdrawals are less than injections then the same country will meet a budget surplus and economic growth.

c) What is equilibrium and how is it achieved?
This occurs when injections are equal to withdrawals. The balance of injections over withdrawals will lead improvement in national income. Increasing the national income households will spend more money on domestic goods but at the same time they will save, pay more taxes, and buy more imports. That will lead to rise in the withdrawals. This will go on until the withdrawals are equal injections, and when this happens the equilibrium will attain.

Q2 With the aid of graphs, explain the following:

a) Output gap -
A difference between the actual output of an economy and the output it might achieve when it is most efficient, or producing at 100%.

b) Potential GDP
The peak of real GDP that could remain unaltered over a significant term of time through avoiding any increase in the inflation percentage.

c) Negative output gap

The negative output gap can be seen when the actual output is less than full-capacity output. Or in other words, the chart shows the negative output gap when an factory operates with a lot of untrained staff, and the production is slow, damaged or none.


d) Positive output gap

A positive output gap occurs when the economy’s real output is above that of its potential output. It looks like almost impossible and indeed in the long run economy cannot produce more than its productive capacity allows. A lot scientist believes that a positive output gap leads to inflation.


e) Explain the possible impact of c and d on the economy

In a situation of output gap occurs a wasteful rate as the economy is overworking or under working its ability. The actual impact on the economy is a constant fluctuation of the rates of production.

Write a short account of the relationship between Inflation and employment—no more than 400 words—anything more than this will not be marked. (100 marks). Attach your report to your assignment.

The relationship between the inflation and employment can be described with one name: “Phillips Curve”. This economist found what actually the connection between the money and unemployment is. The fact is that if the unemployment is low, the wages are rising faster than if the unemployment is high. Usually the inflation is dealing with the rise of interest rates to reduce investment. There is one important thing to say about inflation, that the inflation is two types. The monetary inflation is a too-high growth in the...
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