Nature of the Economy & Circular Flow of Income

Economics: Overview
  • Studies how scarce resources are allocated to satisfy unlimited wants.
  • Focus areas: production, consumption, trade, policy, growth.
Circular Flow of Income: Purpose
  • Visual model linking the five sectors of an economy.
  • Tracks money, resources, goods & services to judge if activity is expanding or contracting.
Sector Roles
Households
  • Own economic resources (land, labour, capital, enterprise).
  • Receive YY (wages, rent, interest, profit) for resources.
  • Spend income on goods & services: CC.
Firms
  • Hire household resources ⇒ produce output.
  • Receive CC; pay YY to households.
Financial Sector
  • Banks channel household/firm savings SS (leakage) into investment II (injection).
Government Sector
  • Collects taxation TT (leakage).
  • Spends on public goods & transfers GG (injection).
Overseas Sector
  • Imports MM (leakage).
  • Exports XX (injection).
Injections vs Leakages & Equilibrium
  • Leakages: S+T+MS + T + M.
  • Injections: I+G+XI + G + X.
  • Equilibrium when S+T+M=I+G+XS+T+M = I+G+X.
    • I+G+X > S+T+M ⇒ economic growth.
    • S+T+M > I+G+X ⇒ economic decline.
Government Intervention
  • Adjusts taxes, spending, regulation or credit conditions to balance flows and stabilise activity.