differentiate money flow and real flow and identify them in the circular flow
Answers
Unlike a traditional economy where production is mainly for self-consumption, production in modern economy is for exchange or sale. Thus, modern economies have become exchange economies where all exchange activities take place through money. In other words, it is money which acts as a medium of exchange in modern economies. Thus, money flows in the form of income and expenditure among different sections of the society.
In this context, it will be relevant to know the views of Paul Studenski who states, “National Income is both a flow of goods and services and a flow of money incomes. It is, therefore, called national product as often as national income.” All the flows in an economy can be classified into Real Flows or money Flows. Remember, households are owners of factors of production as well as consumers whereas firms (or producing enterprises) are producers of goods and services.
Real flows:
These refer to the flows of goods and services. These are real because they consist of actual goods and services. When factor services (services of land, labour, capital, enterprise) flow from household to firms which require them for producing goods and services, these are called real flows. Similarly, when goods and services produced by firms flow from producing enterprises to households who buy them for satisfying their wants, these are also real flows. Such flows are continuous and there is no beginning point or ending point in these flows.
Money flows:
These refer to the flows of money in the form of factor payments and consumption expenditure. The money flows occur since it is through money that various transactions are conducted. It is money that facilitates such transactions bringing flows of money from one sector to another.
When factor incomes (rent, wages, interest and profit) flow from firms to households as rewards for their factor services, these are called money flows. Similarly, when households spend their incomes on purchase of goods and services and as result money flows back to firms, these also indicate money flows.
The difference between the real flows and money flows can be explained further with an illustration. Out of three sectors of an economy—household, firm and government—let us for sake of simplicity consider the first two sectors, viz., household and firm. We assume that there is no government, no saving and no investment.
The firm sector hires productive or factor services (land, labour, capital and enterprise) from the households to produce goods and services. This is real flow. The households, in turn, receive factor income (rent, wages, interest, profit) in the form of money from the firm sector. This is money flow.
With the money income thus earned, the households purchase from firms goods and services like food, cloth, house, shoes, educational, medical and banking facilities, etc. for satisfying their wants. This is real flow from firm sector to household sector. In return, the households make payment to the firm sector in the form of money. This is money flow from households to firm sector.
Based on this simplified model, all these flows involved in it are depicted in the following figure. The inner two arrows indicate real flows which show flow of factor services from household sector to firm sector and corresponding flow of goods and services from firm sector to household sector
The outer two arrows reflect money flows which show flow of factor payments from firm sector to household sector and the corresponding flow of consumption expenditure from household sector to firm sector.