Circular Flow of Money

8 Key excerpts on "Circular Flow of Money"

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  eBook - ePub

  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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  eBook - ePub

  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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  eBook - ePub

  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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  eBook - PDF

  Economics

  A Contemporary Introduction

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

    (Publisher)

  Investment enters the circular flow at juncture (6), so aggregate spending at that point totals C 1 I. Governments must also borrow whenever they incur deficits, that is, whenever their total outlays—transfer payments plus purchases of goods and services—exceed their revenues. Government purchases of goods and services, represented by G, enter the spending stream in the upper half of the circular flow at juncture (7). Remember that G excludes transfer payments, which already entered the stream as income at juncture (3). Some spending by households, firms, and governments goes for imports. Because spending on imports flows to foreign producers, spending on imports, M, leaks from the circular flow at juncture (8). But the rest of the world buys U.S. products, so foreign spend- ing on U.S. exports, X, enters the spending flow at juncture (9). Net exports, the impact of the rest of the world on aggregate expenditure, equal exports minus imports, X 2 M, which can be positive, negative, or zero. In recent decades, net exports have been negative. disposable income (DI ) The income households have available to spend or to save after paying taxes and receiving transfer payments net taxes (NT ) Taxes minus transfer payments financial markets Banks and other financial institutions that facilitate the flow of funds from savers to borrowers Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 20 Tracking the U.S. Economy 453 EXHIBIT 3 Circular Flow of Income and Expenditure The circular-flow model captures important relationships in the economy.

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  eBook - PDF

  Macroeconomics

  A Contemporary Introduction

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

    (Publisher)

  Investment enters the circular flow at juncture (6), so aggregate spending at that point totals C 1 I. Governments must also borrow whenever they incur deficits, that is, whenever their total outlays—transfer payments plus purchases of goods and services—exceed their revenues. Government purchases of goods and services, represented by G, enter the spending stream in the upper half of the circular flow at juncture (7). Remember that G excludes transfer payments, which already entered the stream as income at juncture (3). Some spending by households, firms, and governments goes for imports. Because spending on imports flows to foreign producers, spending on imports, M, leaks from the circular flow at juncture (8). But the rest of the world buys U.S. products, so foreign spend- ing on U.S. exports, X, enters the spending flow at juncture (9). Net exports, the impact of the rest of the world on aggregate expenditure, equal exports minus imports, X 2 M, which can be positive, negative, or zero. In recent decades, net exports have been negative. disposable income (DI ) The income households have available to spend or to save after paying taxes and receiving transfer payments net taxes (NT ) Taxes minus transfer payments financial markets Banks and other financial institutions that facilitate the flow of funds from savers to borrowers Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 6 Tracking the U.S. Economy 121 EXHIBIT 3 Circular Flow of Income and Expenditure The circular-flow model captures important relationships in the economy.

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  eBook - PDF

  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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  eBook - ePub

  Bernard Schmitt's Quantum Macroeconomic Analysis

  • Alvaro Cencini(Author)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  destruction, are equivalent and complementary, the totality of produced output being necessarily purchased by income holders.

  Is this enough to establish that, although these two payments, income creation and income destruction, occur at different instants in continuous time, the circular flow they define is eventually timeless? In other words, although indisputably ‘relative to a given physical output, “income-forming” (IF) and “income-destroying” (ID) payments are successive events in chronological time’ (Schmitt and Greppi 1996 : 361), is it nevertheless possible to maintain that they ‘constitute a timeless identity’ (ibid.: 361)? Schmitt and Greppi show this to be the case, because income creation and income destruction ‘relate to the same physical output’ (ibid.: 361).

  Time and the circular flow of income

  The relationship between income creation and destruction is that of an identity, and identities are timeless. Whatever the interval of time separating the two transactions, no difference can ever be found between the income created by the production of a given period and that spent for its final purchase. This is why production and consumption are the two terms of a logical identity, a necessary condition for the circular flow of income to exist. ‘Circular flow analysis links production and consumption flows so strongly to one another that no production could possibly take place unless simultaneously defined as an equal consumption. To produce means to “produce-consume”. Production and consumption are the two sides of the same “coin”; if one side is nil so is the other’ (ibid.: 351).

  Another way to prove the timeless nature of the circular flow of income is by referring to the relationship between the formation of income and its immediate expenditure by wage-earners. Here, we do not consider income’s final expenditure or destruction as it occurs when physical output is definitively demonetized and appropriated by consumers, but its initial expenditure for the purchase of produced output. What matters here is what happens when wages are paid out to wage-earners.

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  The Political Economy of Monetary Circuits

  Tradition and Change in Post-Keynesian Economics

  • J. Ponsot, S. Rossi, J. Ponsot, S. Rossi(Authors)
  • 2009(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  4. Flows where the rate of flow is a function of the amount of money in the source account are indicated by . These alone are flows as economists conventionally think of them: money flows from one account to another in return for work (payment of wages), goods (con- sumption by workers and bankers), or in return for accepting the legal responsibility of new debt. Table 9.5 shows the 14 relationships in the monetary circuit using this graphical system. These 14 related flows are represented graphically in Figure 9.3. As before, the equations of motion of this system can be constructed by simply adding up the columns of Table 9.4: d dt F L = r L · F L − (1 − δ d ) · r L · F L − F L τ L + B V τ M + n M · F D d dt B V = F L τ L − B V τ M 176 The Political Economy of Monetary Circuits Table 9.5 Links and types of links in full model Number Source Link Type Destination Formula Description 1 F L 1 F L r L · F L Ledger recording of compound interest 2 F D 2 B D (1 − δ d ) · Payment of interest r L · F L on outstanding debt 3 F D 1 F L (1 − δ d ) · Ledger recording r L · F L of interest payment 4 B D 3 F D r D · F D Interest on firm sector’s deposit account 5 F D 4 W D Wages paid to workers 1 − s τ S · F D 6 B D 3 W D r D · W D Interest on workers’ deposit accounts 7 B D 4 F D Consumption by bankers B D τ β 8 W D 4 F D Consumption by workers W D τ ω 9 F D 2 B V F L τ L Repayment of debt 10 F D 1 F L Ledger recording of repayment of debt − F L τ L 11 B V 4 F D Relending from bank vault B V τ M 12 B V 1 F L Ledger recording of bank relending B V τ M 13 F D 4 F D n M · F D Creation of money 14 F L 1 F L n M · F D Creation of new debt d dt F D = r D · F D − (1 − δ d ) · r L · F L − 1 − s τ S · F D + B D τ β + W D τ ω − F L τ L + B V τ M + n M · F D d dt B D = −r D · F D + (1 − δ d ) · r L · F L − r D · W D − B D τ β d dt W D = 1 − s τ S · F D + r D · W D − W D τ ω The transaction-account dynamics of this model are shown in Figure 9.4, and the income dynamics in Figure 9.5.

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