GROWTH ASSIGNMENT

Circular Flow

Model

What is the Circular Flow Model?

The circular flow model is an economic model that illustrates the interdependence that exists between the different sectors operating in an economy.

Households

Overseas

Financial

ProducersGovernment

$Income

Resources

$Consumer Spending

Goods and Services

$Tax

$Transfer Payments

$Government

Purchases

Goods and services

$Savings $Investment

$Import payment

s

$Export Receipts

Assumptions

Developing a circular flow of income for a given situation requires making a few basic assumptions. First, it is assumed that the economy is composed of two basic components, sometimes defined as households and firms. In some models, these are referred to as the residential and business sectors.

Next, the model will not address the existence of an international component, a government component, or a sector that engages in financial services. In short, the circular flow of income will focus on the reciprocal relationship between income earned from firms and how households are using that income to purchase the goods and services offered by the firms.

Limitations

The government has considerable control over the economy, which in turn affects production, employment, and economic growth.

Governments can influence the mix of goods and services offered to households.

The model could also be influenced by pricing factors—that is, the laws of supply and demand. The model does not take into consideration changes in prices or how prices are determined. Nor does it take into consideration how businesses choose the products or services they produce and market.

The Two Sector Model

Households

$Income

Resources/Labor

$Consumer Spending

Goods and Services

Producers

Key:$ - Money Flows - Real Flows

The household sector provides resources for productions (factor inputs) and buys final goods and services.

Sector Model No. 2

In sector model no. 2 there are just households (and producers) where:

Households provide labor to producers in return for which they receive an income. This income is then spent on goods and services through consumer spending. Therefore there are 2 money flows and 2 real flow in this model.

The Three Sector Model

The finance sector includes Financial Institutions- banks and other organisations such as government departments, ministries, and state owned enterprises.

Households

$Income

Resources/Labour

$Consumer Spending

Goods and Services

Producers

Key:$ - Money Flows - Real Flows

Financial$Savings $Investment

Sector Model No. 3

Sector model no. 3 the only difference is that there is a new sector, the financial sector present. Now apart from the real and money flows present in sector 2, there are four more money flows. Households save money in a financial institution in return for which they remove interest on savings whereas these financial institutions lend money to firms or producers as loans for investment in return for which they receive interest on the loans for investments.

The Four Sector Model

The government sector includes Parliament and many organisations such as government departments, ministries and state owned enterprises.

Households

$Income

Resources/Labour

$Consumer Spending

Goods and Services

Producers

Financial$Savings $Investment

Key:$ - Money Flows - Real Flows

Government

$Tax

$Transfer Payments

$Government

Purchases

Goods and services

Sector Model No. 4

Sector model no.4 is the same as sector 2 but for the two sectors, the financial sector which is present in sector model no.3 and the government sector which is neither present in sector model no.2 nor in sector model no.3. No there are four more money flows than there were present in sector 3. The government collects taxes from both consumers(direct tax) and producers(indirect tax). It provides transfer payments for consumers and subsidies for producers.

The Five Sector Model

The oversees sector includes the counties NZ relies on to provide us with market for our exports and to provide us with goods and services we cannot produce as efficiently ourselves.

Households

Financial

ProducersGovernment

$Income

Resources

$Consumer Spending

Goods and Services

$Tax

$Transfer Payments

$Government

Purchases

Goods and services

$Savings $Investment

$Import payment

s

Overseas

$Export Receipts

Sector Model No. 5 Sector model no. 5 has 2 more real flows and 2

more money flows than sector model no. 4. Otherwise it is the same as sector model no. 4 in all other aspects. In sector model no. 5 there are experts for which producers receive export receipts. Then the overseas sector exports gods and services which is the same as our producers importing goods and services. In return for which produces provide them with import payments.

Difference between injections and withdrawals

INJECTIONS WITHDRAWALS

Injections are an addition to money in the circular flow model that increases the level of economic activity

E.g.-Export receipts, investment loans, consumption etc

Withdrawals are leakages from the circular flow model that reduce the level of economic activity.

E.g.-Savings. Taxes etc

Importance of Injections for Economic Growth

Injections are more entering the circular flow therefore increasing economic activity whereas economic growth is an increase in the actual output.

So with more money entering the circular flow, firms will make more profit and consumers will demand more as they will have higher disposable incomes therefore to satisfy consumer’s wants and make a higher profit, producers will produce more therefore increasing the actual output and therefore being important for economic growth as it increases it.

Injections are important for economic growth.

How an increase in household savings causes growth

Savings increase. This results in greater savings received by the financial sector. Firms can now increase investments as the financial sector has more money to lend out and so firms purchase more capital goods to increase productivity as productivity measures output per person and so if there are more machines more can be produced with the same amount of people present and therefore production increases. Therefore growth occurs as there is an increase in the output that is overall being produced.

How an increase in firms investments causes growth

Due to an increase in investments, due to maybe more subsidies being provided by the government more resources are purchased to produce more goods and services. Therefore consumer’s income increases as they work longer and firms become more profitable and so more goods and services are produced as there is an increase in consumer spending due to greater incomes of consumers and there is an increase in growth as there is an increase in the overall output produced.

How an increase in resource use causes growth

As the output increases more resources are required to make the extra output and so consumers income increases as they work longer hours to provide the extra resources and so, consumer spending increases as they now have a greater disposable income therefore the levels of goods and services produced increases to satisfy greater consumer wants and demand. So growth increases because more is being produced overall.

How an increase in consumption causes growth

An increase in consumption will result in an increase in consumer spending as more goods and services are being purchased. Firms will now be more confident as more of their products are being demanded and will therefore increase output to make more profit and to keep up with the increase in demand. They will increase investments to purchase more capital goods or hire more workers and increase production. Therefore worker’s incomes will increase as more will work or they will work for longer hours, therefore household savings increase due to greater incomes and so growth occurs as there is now an increase in the productive capacity in the economy.

How in increase in exports causes growth

An increases in exports due to firms producing more of their products will result in an increase in export receipts as firms will make more profit by selling more overseas. Therefore their investments increase further increase production. This leads to an increase in output as there will be more capital goods due to more investments and therefore more is produced. Consumer’s income increases as they will work longer hours for firms to produce greater output and therefore growth increases as there is an increase in the production capacity now.

How an international event being held in New Zealand(NZ) causes growth

An international event being held in NZ results in an increase in tourism so export receipts increase as more tourists pay for NZ services, se spending in regions increase as there are more tourists in these regions. So firms confidence increases so investments increases as they will want to make a greater profit and because they have so many customers due to the international event. Therefore to keep up with the extra demand, producers will employ more workers, therefore causing consumers income to increase as more work or the same no. of workers work longer hours. So due to greater disposable income now consumer spending increases, therefore causing growth to increase as the economy is growing.