The state of equilibrium in the two-sector economy is defined as a situation in which no change occurs in the levels of income Y , expenditure E , and output O. Unsourced material may be challenged and. The household sector owns all the factors of production that is land, labor, capital and enterprise. Likewise, people of other countries purchase goods and services not produced domestically i. The circular flow of income or circular flow is a of the in which the major exchanges are represented as flows of , and , etc. The consumption spending of households is in return for the goods and services that flow from firms to households. Because the exchange of legal claims involves the counter flow of income, those seeking to save income buy legal claims and those wanting to borrow income sell legal claims.
Government purchases goods and services just as households and firms do. This is not to say that the circular flow diagram isn't useful in understanding the basics of an economy, such as leakages and injections. Government will levy on household and firm. By net capital inflow we mean foreigners will borrow from domestic savers to finance their purchases of domestic exports. In a simple economy which has neither government, nor foreign trade, the value of output produced which we denote by Y is equal to the value of output sold.
But Govt purchases the services of the household, makes transfer payments in the fort of old age pensions, unemployed, relief etc and spends on the social services like education, health, etc. The amount that the government collects in taxes need not equal the amount that it pays out for government purchases and transfers. These government expenditures are injections into the circular flow of money. Households sell their factor services to firms in the factor markets and in exchange receive wages the left hand side of the flow. Important developments of Quesnay's tableau were ' reproduction schemes in the second volume of , and '.
It is given the code ' M' for imports. To this we add the government sector so as to make it a three-sector closed model. Likewise, there are many services rendered by business firms to foreign countries such as shipping, insurance, banking etc. This means that the expenses made by the households become the source of income for the business sector or the firms and vice versa. In the open economy there is interaction between countries not only through exports and imports of goods and services but also through borrowing and lending funds or what is also called financial market. In such a case the Govt reduces the public debt and supplies fund to the capital market which are received by firms.
Here we saw product market and factor market. On the other hand, purchases of foreign-made goods and services by domestic households are called imports. Economists call the wages plus the other forms of income, national income and give it the code ' Y'. If we illustrate these interactions, we can see that both money and goods and services move from one sector to the other in a circular motion. Figure 4 Circular flow - 3 sector, open economy What will be the equilibrium condition for this economy? A flow of money spending on imports have been shown to be occurring from the domestic business firms to the foreign countries i.
On the other hand, the government purchases all its requirements of goods of all types from the business sector, gives subsidies and makes transfer payments to firms in order to encourage their production. The circular flow of income described above is the most simplistic illustration of the interdependency of two sectors in the economy. Exports are an injection or inflows into the economy. But in that analysis we referred to planned or intended investment and savings which often differ and affect the flow of national income. There is no financial sector.
A result, circular flow of money speeding and income remains undiminished. When there is a trade surplus in the economy, that is, when exports X exceed imports M , net capital inflow will take place. Households describe all economic actors that are consumers of goods and services. Thus any income that they receive today but wish to put aside for the future is sent to the financial markets. This approach of breaking down a problem has been appreciated by majority of our students for learning Balance of payments sector, Government expenditure concepts.
The reduction in consumption leads to decrease in the sales and incomes of the firms. Money Income Flows in the Four Sector Open Economy: Adding Foreign Sector: We now turn to explain the money flows that are generated in an open economy, that is, economy which have trade relations with foreign countries. The economy can only continuing churning if it has matter and energy to power it and the ability to absorb the waste it creates. When Govt, takes money in form of taxes, the ability to spend of the taxpayer is reduced but this is offset through spending more on the purchase of goods and services called injection. This equation is called the national income identity and is the most fundamental relationship in the national accounts.
This will lead to the fall in total incomes of the households. Please do send us a request for Balance of payments sector, Government expenditure tutoring and experience the quality yourself. Expenditure has now two paths: i Directly via consumption from the households to the business sector, and ii Indirectly via investment expenditure by the business sector. The leakage that the Government sector provides is through the collection of revenue through Taxes T that is provided by households and firms to the government. Such savings of consumers and firms are not hoarded but are invested in bonds, shares, debentures, etc.