Explain circular flow of Income.
Answers
Answer:
Explanation:
The circular flow of income is a neoclassical economic model depicting how money flows through the economy. In its simplest version, the economy is modeled as consisting only of households and firms. Money flows to workers in the form of wages and money flows back to firms in exchange for products. In short, an economy is made up of countless circular flows of income (or money).
Understanding Circular Flow Of Income
Most, if not all, people go to work daily to earn a living. The money that is earned is used to purchase goods and services from businesses such as food, clothes, rent, basic commodities, entertainment services, health and wellness products, etc. The income earned daily flows back to businesses continuously in a cycle known as the circular flow of income.
Businesses and companies manufacture goods or provide services to consumers. To increase sales and profits, these companies use factors of production - labor, capital, and land - to run their operations and grow their businesses. In return for their services, the hired labor is given a wage or salary, known as income. The income received is used by households and individuals to purchase the goods and services produced by these businesses. The businesses use the proceeds from the sales to produce more products and pay workers for their labor.
Enhancing Circular Flow
The circular flow of income described above is the most simplistic illustration of the interdependency of two sectors in the economy. However, actual money flows through the economy are far more complicated. Economists have expanded on the ideas of the circular flow of income model to better depict the complexity of modern economies by including more sectors that affect money flow. In addition to the household sector that spends (C) goods and the business sector that produces the goods, two sectors that are also included in the circular flow of income include the government sector and the foreign sector. The government injects money into the circle through government spending (G) on things like welfare programs and infrastructure. Money is also added to the circular flow through exports (X) which involves foreign entities purchasing goods from the economy. Businesses that invest (I) money to purchase capital stocks contribute to the flow of income in the economy.
Just as money is injected into the economy, money can also be withdrawn or leaked through a number of activities. Taxes (T) imposed by the government reduce the flow of income. Money that is used to pay foreign entities for goods and services through imports (M) also constitutes a leakage. Finally, savings (S) of businesses which could otherwise have been invested leads to a decrease in the circular flow of an economy’s income.
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Answer:
The circular flow of income or circular flow is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. between economic agents. The flows of money and goods exchanged in a closed circuit correspond in value, but run in the opposite direction.