To stop further reduction in their inventories, they will increase production. As such, the circular flow is of immense significance for studying the functioning of the economy and for helping the government in formulating policy measures. On the other hand, if injections into the circular flow exceed leakages, the income is increased in the economy. In fact, the basis of the Keynesian multiplier is the cumulative movements in the circular flow of income. But in the long run, exports of an economy must balance its imports.
Proportional Income Tax and Balanced Budget Multiplier : In the above, we have discussed the impact of lump-sumtax only on the national income. In highly developed countries with a high income, the tertiary sector dominates the total output of the economy. If total injections exceed total leakages more money is being added than removed, therefore income and expenditure will rise leading to a demand for goods and services leading to higher rates of unemployment meaning unemployment will fall. But savings by households need not lead to reduced aggregate spending and income if they find their way back into flow of expenditure. Thus aggregate demand is less than aggregate supply. Illustration 22 In an economy, the full employment output occurs at 2000 millions. Saltaire factor by the River Aire.
Equality of Aggregate Demand and Aggregate Supply : The equilibrium level of national income is determined at a point where the aggregate demand function curve intersects the aggregate supply function. Investment relates to net investment after deducting depreciation. This tends to reduce employment, income and prices, thereby leading to a deflationary process in the economy. A flow of money spending on imports have been shown to be occurring from the domestic business firms to the foreign countries i. In a two sector model, a part of the current income stream leaked out as saving whereas injections in the form of investment were injected into the system. On the contrary, in case of import surplus, that is, when imports are greater than exports, trade deficit will occur.
Let us see few illustrations relating to a three sector economy. Another method of financing Government expenditure is borrowing from the financial market. This sector receives income by selling the services of these factors to the business sector. Now we take the household, business and government sectors together to show their inflows and outflows in the circular flow. For national income to be in equilibrium desired saving plus taxes S+T must equal desired investment plus government spending I + G. This is shown in Panel B of Fig.
If value of exports exceeds the value of imports, trade surplus occurs. In Figure 2 there is a capital or credit market in between saving and investment flows from households to business firms. The marginal propensity to consume is 0. As a result of fall in planned investment expenditure, income, output and employment will fall and therefore the flow of money will contract. The main weapon of monetary policy is the rate of interest. However, an eminent British economist J.
There are no corporate firms in the economy so that there are no corporate undistributed profits. As a result, the demand for machinery production in the secondary sector increases. Thirdly, we assume that the economy neither imports goods and services, nor exports anything. The raw material — wool from sheep. On the contrary, flow of money expenditure on exports of a domestic economy has been shown to be taking place from foreign countries to the business firms of the domestic economy. The less developed countries exhibit the inverse pattern. It was developed by , and.
These can be renewable resources, such as fish, wool and wind power. In other words, the government does not receive any money from the people by way of taxes, nor does the government spend any money on the goods and services produced by the firms or on the resources and services supplied by the households. By using its budget therefore the government can influence the levels of income, output and expenditure for the economy as a whole. Students may investigate the organizations on the internet to help determine the economic sector. The business sector consists of producers who produce products and sell them to the household sector or consumers.
For this, we add taxation and government purchases or expenditure in our presentation. Change in Lump Sum Tax and the Tax Multiplier : The impact of change in lump-sum taxes on the national income is similar to the impact of government expenditure. On the other hand, imports are leakages from the circular flow. If total leakages exceed total injections the level of spending in the economy will fall leading to the decline for goods and services leading finally to unemployment. Study of Problems of Disequilibrium: It is with the help of circular flow that the problems of disequilibrium and the restoration of equilibrium can be studied. It also comprises the top decision-makers in industry, commerce and also the education sector.