Circular Income Flow in Macro Economy - Research Paper Example

Circular income flow in Macro economy Circular income flow in macro economy; A closed economy consists of two units: households and firms. Both of these in conjunction generate national expenditure and national output of a given country. For instance, household’s main objective is to provide basic resources of production. Examples are capital, land, and labour. These production basics generate their rewards as interest, rent, and wages respectively (Williamson, 2005). However, the firms’ main objective is to supply goods and services for both local and foreign consumption.

A closed economy is an economy that is independent and self-centered. It is an economy that does not have trading links with external firms apart from itself. In this case, goods are produced locally when it comes to trade .There is neither exportation nor importation of goods and services. Its main primary objective is to provide all the necessary needs and wants within its locality or vicinity. The trade is only conducted within its regional blocks. Because of this, it thus lowers the living standards in the economy.

Diversification in economy is not fully maximized and utilized. Specialization of labour is highly motivated and experienced .In this economy produced outputs are purchased and sold locally. Its national expenditure consists of consumption, government spending and Investment (Y=C+G+I) (Abraham, 2009).Example of this economy is the use of a single common currency that has been greatly and generally accepted in Western European nations. On the other hand, an open economy operates both locally and internationally beyond its trading and regional blocs.

It’s more like an internal and external trade .Businesses that accrue involve importation and exportation of commodities .This economy results into increased living standards and healthy competitions among trading nations. In addition, it encourages investment growth globally and the creation of new markets. In this case, savings curve is achieved because of supply curve whereas investment is as a result of demand curve to obtain equilibrium in the economy. Its equation is represented as Y=C+I+G+(X-M).

Considering this phase, the government might take part in the economy to purchase local goods using their domestic production inputs. Inner and outer system circular flow of a closed economy takes place domestically on domestic products as compared to purchasing of goods and services. This scenario creates leakages to households. However, in an open economy withdrawals generated from households are viewed as a portion of a given nations economy. Since these leakages pump in and inject more money into the economy.

This money is as a result of external source from households and firms. Taxes and savings are not economically spent during this period. This causes the household units to spend more money. Leakages are non-consumption commodities such as imports that are driven out of a given country’s economy .Consequently; this may cause a trade off and deficit in a country impacting its economical growth negatively. Moreover, minimal leakages in an economy lead to surplus in budget and also the economy’s growth.

Examples of leakages in an economy include savings and taxes plus imports. On the other hand, injections are commodities that in monetary terms directly or indirectly provide services to economy. Examples of injections include exports, investments and government purchases (Elliott, 2007).In open economy commodities are sold in other countries thus making it to separately subtract exports from imports. After the difference, both the consumption and investment are added to realize the total amount spent.

Says law perfectly explains the total spending accrued in an economy. It states that total output produced will be equal to the total amount spent. Under the classical approach households will always import their goods from other countries and inhabitant of the other country might also want to get goods from the trading partner but not at more quantity as compared to the latter. Diagrammatically closed circular flow can be shown as below Salaries and rents Production factors ( e.g land and labor ) Individuals and households Firms and industries Products and services Cash Below is a diagrammatic representations of open economy Salaries and rents Production factors ( e.

g land and labor Individuals and households Firms and industries Public utilities Public utilities Products and services Cash Savings + Taxes + Imports = Investment expenditure + Government Expenditure + Exports (Leakages) = (injections) In conclusion, the above models explain the flow of income between different sectors of the economy. Income flows from the households firms and back from the firms to the households in a cyclic manner hence referred to as the circular flow of income. Money withdrawn as savings, taxes is reintroduced into the circular flow of income by: Investment expenditure by the firms that borrow from the firms to buy factor services for producing goods and services, Government expenditure of providing goods and services to the public and the firms.

Withdrawals from the circular flow in the form of leakages are savings, taxes, and imports. Injections are factors increasing national income and are exports, investment funds, and government expenditure. References Abraham, W. I. (2009). National Income and Economic Accounting. Englewood Cliffs, N.J.: Prentice-Hall. Elliott, J. W. (2007). Macroeconomic Analysis. Cambridge, Mass.: Winthrop Publishers. Williamson, S. D. (2005). Macroeconomics (2nd ed.). Boston: Pearson Addison Wesley.