![]() ![]() Borrowers take money out of these institutions to fund consumption and investment (as well as government budget deficits) their demand and the available supply of loanable funds generally set the interest rate - the price to borrow or save money.Įxporters and importers simply represent the foreign sector of the macroeconomy. Savings are deposited in financial institutions, and these create a supply of money to be loaned out. Through payroll of government employees, transfer payments, purchases of goods and services, and loans from the Federal Reserve System, the government also returns money to both firms and households alike.įinancial institutions are firms such as banks, savings and loans, and credit unions that provide the service of acting as a repository of loanable funds. Though taxes and other fees, government siphons money out of the private sector to provide certain goods ans services which firms cannot or would not normally (such as police protection and national defense). Government, at all levels, acts primarily as both a consumer and supplier of goods and services it also at time provides factors of production to firms. Households demand goods and services that firms produce, while at the same time supplying firms with factors of production - land, labor, capital, and entrepreneurship - in exchange for payments from firms that are collectively called income. In exchange for the goods and services they produce, they receive payments which are collectively called revenue. If 'Income' rises for example, then the others will rise too.Essentially, the functions break down as follows:įirms supply both intermediate and final goods and services available in the economy, while demanding the factors of production which they must consume in order to produce those goods and services. If injections are greater than leakages that there is a net positive income in our economy and this is what causes GDP growth. Injections have to be greater than leakages. How do we achieve economic growth in this model? Things like public services, roads and buildings etc are all funded by the government. Government Spending - the government can't just tax us and keep all the money, otherwise why would we pay tax? The government uses the taxation money that receive from us, and they spend money on keeping the country running. Capital goods are goods that firms need to make output.Įxports - some of the money that enters our circular flow is from other countries. Investment - some of this money is invested by firms towards the purchase of capital goods, for example. It is money that enters our circular flow of income. Every country with a government will have a tax law which citizens have to follow.ĭo you notice the bright green lines in the diagram? These are our injections. Taxes - some of the money is taxed and transferred to the government. Do you see on the diagram how we give money to other countries and it enters their circular flow of income. Imports - some of the money is transferred between our circular flow and another country's. They hold back some of their income for future emergencies or future purchases. Saving - some of the money is saved by households. This is the money that exits our circular flow. We have governments we pay taxes to, other countries that we buying imports from and we also do not spend all of our money.ĭo you notice the red lines in the diagram? These red lines are our leakages or withdrawals. ![]() The above model is a more realistic view of our income. We need firms to be making more output so we need more expenditure and income etc. This proves the condition above is true and shows what we need for economic growth to occur. And if the firms make extra outputs, they must hire extra inputs and pay extra income. ![]() How can we show economic growth using this condition?Īny extra money spent will be reflected by extra output that the firms make. There are no purchases of imports or exports.įrom the diagram above we can also see the following condition is true: It assumes a few things:Ģ) The market is a closed economy. This is shown as the flow of income between firms and households on the diagram. These factor inputs are land, labour and capital.Ĥ) The firms must pay the factor rewards to the factors of production. ![]() The more expenditure they receive, the more outputs they will produce.ģ) Firms produce these outputs by hiring factor inputs. This is called expenditure.Ģ) Firms respond to the expenditure by producing outputs. The diagram above shows the most basic circular flow of income model.ġ) Money flows from households to firms on the right hand side. ![]()
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