Circular Flow of Income

10 Key excerpts on "Circular Flow of Income"

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  eBook - PDF

  Time and the Macroeconomic Analysis of Income

  • Alvaro Cencini(Author)
  • 2013(Publication Date)
  • Bloomsbury Academic

    (Publisher)

  The relation can be viewed as a conceptual one, the Circular Flow of Income in the economy; 22 THE DEFINITION OF NATIONAL INCOME or it can be put in the framework of the aggregates of national income accounting. The Circular Flow of Income is illustrated in [Figure 1.9] in purely schematic terms. It does not matter where we start but we must follow the direction of the flow of income. 36 Fig. 1.9. The circularity is explicit: wherever we start we shall come back to the same point, since income moves in a circular flow. This hypothesis becomes even more evident once we are told that output Q and income Y are in fact the same object. The third lag is not of the same importance as the other two, and in the models we treat in the present text, we always assume that there is no lag between output and income. Taking a zero lag of the third type, we can write output Q and income Y interchangeably. When we concentrate attention on the production aspects of the economy, e.g. in writing a production function, then we may use Q for output. But in general it is enough to write Y for income and output alike. Effectively, then, there are two distinct aggregates, demand Z and income (output) 7. 37 Now, if demand Z and income Y are the only two dis-tinct concepts and if, moreover, income is moving in a cir-cular flow it necessarily follows that income is conserved through its own demand (expenditure). This result is stressed by Allen himself when he represents the flow of national income. THE DEFINITION OF NATIONAL INCOME 23 The circular-flow scheme of [Figure 1.9] can be translated into national income terms. We show the translation in the form of [Figure 1.10]. Apart from lags, the aggregate of incomes is the national income Y the aggregate demand is the sum of all purchases of goods and services or the national expenditure Z; and the aggregate of output is the production of all goods and services or the national product Q.

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  Introduction to the World Economy

  • A J Brown(Author)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  CHAPTER 3 The Flows of Money

  MOST economies, as we have seen, are market economies in which individual families or productive enterprises do not produce most of what they themselves consume or store up, and do not themselves consume or store up most of what they produce—they sell most of their products for money and buy with money most of what they consume, or of what they add to their stocks of goods and equipment. In such an economy, therefore, most production is not simply an immediate attempt to meet the producers’ wants, and, except where production is centrally planned, the aggregate investment which comes about is not the result merely of decisions that so much ought to be accumulated. Between production on the one hand and consumption or accumulation on the other there intervene one or more exchanges of goods or services against money.

  The Circular Flow

  In order to form a clear picture of the monetary machinery by which a market economy works, let us start with the simplest kind of situation, in which all output is produced by enterprises (not necessarily private) for sale, and in which there is no saving, no foreign trade, and no taxation. In such a community, a sum of money equal to the full value of output is paid out in each period by enterprises to the people who provide them with labour, capital, or materials, or who draw profits from them—that is to say, this sum is paid out to households. The whole of this money is then paid back by households to enterprises in exchange for the goods which they want to consume.

  Now, it can be seen that, if the volume of production does not change, a simple system of this kind can go on working indefinitely, with a constant amount of money. Ignore profits for a moment and suppose that all the payments connected with production consist of wages, salaries, and similar items which are paid out at the end of each week. Then what households have in hand at the beginning of this week will be precisely the cost of producing last week’s output, and by expending this sum during the week they can buy all of last week’s output at a price equal to its cost of production. Profits introduce a slight complication. In practice, of course, enterprises normally rely upon selling their output at a price which covers more than their out-of-pocket payments in connection with its production. If, however, we suppose that output is going on at the same level, week by week, the difficulty vanishes. It is true that there will not be enough money in households to buy last week's output at prices which allow for profits unless those profits have already been paid out, and that the profit on a particular batch of goods is not even earned until the goods are sold. With a constant output of goods week after week, however, there will always be some profits available in households to help buy the goods produced in the previous week, even though it is profit earned, not on those goods themselves, but on an earlier batch—perhaps the batch which was sold in the previous week and produced in the week before that. It is plain, then, that a steady stream of production, and its sale, can be financed by the circular flow of a fixed amount of money (how much is required we shall have to enquire later), between enterprises and households. If the volume of production is for any reason increased, there are further complications: the enterprises will have to find more money from somewhere to pay their increased wage-bill, etc., and households will also have to find some more in order to buy the first enlarged batch of goods in advance of receiving the enlarged profits on them; but that need not concern us at the moment.

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  Microeconomics in Context

  • Neva Goodwin, Jonathan M. Harris, Julie A. Nelson, Pratistha Joshi Rajkarnikar, Brian Roach, Mariano Torras(Authors)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  The two actors (households and firms) are represented by rectangles, the activity of exchange by the blue and gray arrows. Flows of goods or services create the clockwise flow of the outer circle. Households are considered the ultimate owners of all assets, including land (or natural resources), physical capital (such as factories and machinery), and financial capital. They supply the services of these assets, along with their labor, to firms via factor markets. (We’ll discuss exactly what we mean by “markets” in the next chapter.) Firms use these to produce goods and services, which return to the households via product markets. Households are consumers, buying and using these products. Flows of monetary funds, exchanged for these goods and services, move in the opposite direction around the inner circle. circular flow diagram: a graphical representation of the traditional view of an economy consisting of households and firms engaging in exchange factor markets : markets for the services of land, labor, and capital product markets : markets for newly produced goods and services ■ Figure 1.5 The Circular Flow Diagram This diagram is useful in portraying in a very simplified way two of the major actors (households and firms) and three of the major activities (production, exchange, and consumption) involved in economic life. However, it is important to recognize that the model leaves out some key actors and activities. For example, while “land” is included as a factor of production, the fact that natural resources can be used up or polluted is not portrayed. Because of this, the circular flow diagram is a little like a “perpetual motion machine”; the economy it portrays can apparently keep on generating products forever without any inputs of materials or energy. The necessity of wise resource management is not included. Also, the diagram only takes into account flows of goods or resources that are paid for through the market (the inner, gray arrows show these payments)

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  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  C H E C K P O I N T Describe the two ways of computing GDP and explain why they are equivalent. 6-2 Circular Flow of Income and Expenditure The model in Exhibit 3 outlines the Circular Flow of Income and spending in the econ- omy for not only households and firms, as was the case in Chapter 1, but governments and the rest of the world. The main stream flows clockwise around the circle, first as income from firms to households (in the lower half of the circle), and then as spending from households back to firms (in the upper half of the circle). For each flow of money, there is an equal and opposite flow of products or resources. Here we follow the money. 6-2a Income Half of the Circular Flow To develop a Circular Flow of Income and spending, we must make some simplifying assumptions. Specifically, by assuming that physical capital does not wear out (i.e., no capital depreciation occurs) and that firms pay out all profits to firm owners (i.e., firms retain no earnings), we can say that GDP equals aggregate income. The circular flow is a continuous process, but the logic of the model is clearest if we begin at juncture (1) in Exhibit 3, where U.S. firms make production decisions. After all, production must occur before output can be sold and income earned. As Henry Ford explained, “It is not the employer who pays the wages—the employer only handles the money. It is the product that pays wages.” Households supply their labor, capital, natural resources, and entrepreneurial ability to make products that firms sell to pay wages, interest, rent, and profit. Production of aggregate output, or GDP, gives rise to an equal amount of aggregate income. Thus, at juncture (1), aggregate output equals aggregate income. But not all that income is available to spend. At juncture (2), governments collect taxes. Some of these tax dollars return as transfer payments to the income stream at juncture (3). By Copyright 2017 Cengage Learning. All Rights Reserved.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  C H E C K P O I N T Describe the two ways of computing GDP and explain why they are equivalent. 20-2 Circular Flow of Income and Expenditure The model in Exhibit 3 outlines the Circular Flow of Income and spending in the econ- omy for not only households and firms, as was the case in Chapter 1, but governments and the rest of the world. The main stream flows clockwise around the circle, first as income from firms to households (in the lower half of the circle), and then as spending from households back to firms (in the upper half of the circle). For each flow of money, there is an equal and opposite flow of products or resources. Here we follow the money. 20-2a Income Half of the Circular Flow To develop a Circular Flow of Income and spending, we must make some simplifying assumptions. Specifically, by assuming that physical capital does not wear out (i.e., no capital depreciation occurs) and that firms pay out all profits to firm owners (i.e., firms retain no earnings), we can say that GDP equals aggregate income. The circular flow is a continuous process, but the logic of the model is clearest if we begin at juncture (1) in Exhibit 3, where U.S. firms make production decisions. After all, production must occur before output can be sold and income earned. As Henry Ford explained, “It is not the employer who pays the wages—the employer only handles the money. It is the product that pays wages.” Households supply their labor, capital, natural resources, and entrepreneurial ability to make products that firms sell to pay wages, interest, rent, and profit. Production of aggregate output, or GDP, gives rise to an equal amount of aggregate income. Thus, at juncture (1), aggregate output equals aggregate income. But not all that income is available to spend. At juncture (2), governments collect taxes. Some of these tax dollars return as transfer payments to the income stream at juncture (3). By Copyright 2017 Cengage Learning. All Rights Reserved.

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  Management Economics: An Accelerated Approach

  An Accelerated Approach

  • William G. Forgang, Karl W. Einolf(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  2

  Aggregate Output, Prices, and Economic Indicators

  This chapter develops a model of a free market economy, contributes to our understanding of the macroeconomic environment, and examines the determination of the economy’s aggregate output. Economic indicators are presented to help decision makers monitor the state of the economy and to align choices with the realities of the marketplace.

  Learning Objectives

  The successful reader understands:

  • The nature of free market economies

  • The role of aggregate demand in the determination of aggregate output

  • How to use economic indicators to monitor the macroeconomy

  • The multiplier and the interactions between components of aggregate demand

  • The concept of aggregate supply and the relationship between aggregate supply, employment, and inflation

  • Fiscal policy and supply-side economic policy

  • How the macroeconomy affects business and personal decisions

  The Circular Flow of Income

  Figure 2.1 depicts a two-sector (households and businesses) market economy. Both participants are defined by their activities. Households own the resources used in the production process and express a force of supply in the resource market, and they use the income earned in the resource market to express a force of demand in the goods market. Businesses express a force of demand in the resource market based on the expectation of producing a good or service salable for profit, and they express a force of supply in the goods market to sell their products.

  The circular flow model is a useful tool in microeconomics. It shows the interactions between buyers and sellers and the role of the goods market and the resource market. The model assumes both households and businesses are motivated by self-interest. Households seek the highest possible payment for their resources and the lowest possible price for goods and services. Businesses have opposing objectives, seeking to pay the least for the resource inputs while realizing the highest price for their good or service. The interactions of the forces of supply and demand (examined more closely in Chapter 4

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  Principles of Economics in a Nutshell

  • Lorenzo Garbo, Dorene Isenberg, Nicholas Reksten(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  5

  Understanding the wealth of nations

  National income accounting

    5.1

  Circular flows and fundamental macroeconomic identities

  We now need to shift our focus from a micro to a macro level. In the microeconomics section of the book we paid attention to the behavior of single agents of the economy, specifically the consumer and the producer (the firm). The variables we used were pertinent to these agents: fundamentally the relationships between price and quantity of goods and services, studied from the point of view of consumers and suppliers, respectively.

  A macroeconomic story, and some macroeconomic vocabulary

  When we approach the macroeconomy, the aggregate economy of a country, a region, and so on, the functions of the various economic agents change, as agents are not seen only as relating to a specific market but become the integrated engines of the economy taken as a whole.

  Thus, households not only demand goods and services, but also supply labor and capital to the production processes of the country. In exchange, they receive income that can be used to purchase consumption goods and services, pay taxes, and add to the households’ savings. Households’ savings are placed in the financial sector : banks receive savings and turn them around in the form of lending to firms for their investments , i.e., to purchase capital goods that will further their production processes in the future. The amount of lending banks can do out of the savings they receive is regulated by the central bank (the Federal Reserve System in the US), and the economic policy implemented by the central bank of a country is known as monetary policy. Firms

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  Principles of Economics in Context

  • Neva Goodwin, Jonathan M. Harris, Julie A. Nelson, Brian Roach, Mariano Torras, Jonathan Harris, Julie Nelson(Authors)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Because of this, the circular flow diagram is a little like a “perpet -ual motion machine”; the economy it portrays can apparently keep on generating products forever with-out any inputs of materials or energy. The necessity of resource management activities is not included. Also, the diagram only takes into account flows of goods or resources that are paid for through the market (the inner, light blue arrows show these payments). This ignores unpaid work and free use of natural resources, among other things. You will also notice that there is no role for government in this diagram. While this oversimplification has some value, in allowing us to focus only on the workings of specific markets, it limits our ability to present a broader picture. The simplified circular flow diagram also ignores the sociocultural and historical aspects that affect economic behavior. This is partly due to the difficulty associated with measuring aspects such as envi -ronmental impacts, unpaid work, and social and cultural factors. Economists are often inclined towards focusing on quantitative analysis to produce definite answers and policy recommendations. Despite the usefulness of such analysis, valuable information may be lost when ignoring aspects that directly influ -ence economic behavior and outcomes. For example, mining activity will increase productive output, but may also pollute streams and damage livelihoods for people living close to the mine. Increased production of food through intensive agriculture also boosts output, but may drive out family farms. This may be particularly harmful to women in developing countries if it eliminates their traditional roles in farm pro-duction. Hence, it is important to consider economic activities in the context in which they occur. 2.2 T HE C ONTEXTUAL M ODEL As discussed above, economic activities take place within environmental and social contexts.

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  Thomas Robert Malthus

  • David Reisman(Author)
  • 2018(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  © The Author(s) 2018 David Reisman Thomas Robert Malthus Great Thinkers in Economics https://doi.org/10.1007/978-3-030-01956-3_8

  Begin Abstract

  8. The Circular Flow

  David Reisman

  1  

  (1) Nanyang Technological University, Singapore, Singapore

   

  8.1 Wealth

  8.2 Value

  8.3 Say’s Law

  8.4 Oscillation and Trend

  8.5 The Golden Mean

  8.6 Restoring the Balance

  References

  Keywords

  Circular flow Aggregate over-supply Involuntary unemployment Wealth Value

  End Abstract

  There is production: land, labour and capital are combined in such a way as to generate final output where previously there had been only promise and potential. There is realisation: consumption, investment , government expenditure and net exports are national expenditure that finds the national product a home. A nation wants sustainable growth in its productive capacity without wasteful over-heating, underperformance or stagnation. A nation does not always get what it wants.

  Malthus was the spiritual heir to Adam Smith on self-sustaining growth. Yet he was also the witness to wars, disruptions, downturns and unemployment. If the population mechanism did not condemn honest men and women to vice and misery, then the circular flow might itself leave them hungry and poor.

  8.1 Wealth

  Today, the definition is different. In the shadow of great economic statisticians like James Meade , Richard Stone and Simon Kuznets (Reisman 2017 : 20–24), the national product is defined to be the sum of new value added in a nation in a reporting year. Wherever possible it is measured through revealed preferences and subjective satisfactions rather than through the accountant’s paid-out costs or physical quantities. No distinction is made between goods and services . Primary, secondary or tertiary, if it crosses the frontier from firms to households it is a part of the national income .

  Today, every student has been schooled in the standard catechism. Things were different in the crucible years. The Physiocrats defined the real wealth of the nation to be the net primary surplus. Smith said it was ‘the annual produce of its land and labour’ (Smith 1776 [1961 ]: I 267). Lauderdale made it ‘all that man desires as useful and delightful to him’ (Lauderdale 1804 : 57). Malthus followed Smith when, most of all in his Principles in 1820 and his Definitions

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  An Introduction to Economics for Students of Agriculture

  • Berkeley Hill(Author)
  • 2013(Publication Date)
  • Pergamon

    (Publisher)

  The economist has to take into account that most changes in the economy — such as the building of a new airport — have implications for many sectors of society. Some implications will be beneficial, others deleterious. Only some are readily quantifiable and an assessment of the desirability of growth, or indeed any change in society, must in the last resort be a sub-jective judgement. This section has emphasised the interrelationships of individuals and firms, both singly and collectively. Such interactions are not confined to within the national boundary and a natural extension is the notion of international trade, considered next. Exercise on Material in Chapter 8 8.1. Which of the following are injections into the Circular Flow of Income, which are withdrawals and which neither? (a) Saving of wages by workers (b) Wages paid to civil servants by the Government Macro-economics - the workings of the whole economy 263 (c) Spending by foreigners on British exports (d) Income Tax (e) Investment by a firm in new machinery (f) A gift of £5 from a father out of his spending money to his son (g) Spending of wages by workers Cross out the inappropriate alternatives: The Marginal Propensity to Withdraw is the proportion/amount of any increase in average/total income which is withdrawn by saving, taxation, purchase of imports etc. If saving is the only withdrawal from the Circular Flow of Income, and the Marginal Propensity to Save, is 0.25, what will be the size of the multiplier? Cross out the inappropriate alternatives: National Income will be in equilibrium when the intended level of injections is greater than/less than/equal to the intended level of withdrawals. The equilibrium level must alwaysIneed not correspond to one at which all the nation's productive resources are fully employed.

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