Circular Flow of Expenditure and Income - Example

Circular Flow of Expenditure and Income The various definitions of an economy have the tendency in defining one integrated system leading up to production, its exchange and consumption. The activities in an economy and the transactions the players in the economy make are party to the economy. People are the greatest and the most important props in the running and the well-being of an economy. The people are in charge of the decisions of buying and selling of goods and services. Economies base themselves on these core activities mentioned. In an economy that is functioning properly, the transactions generated in two major groups: there is the real flow that is concerned with the flow of goods and services and there is the money flow. The money flow is concerned with the circular movement of money in the said economy. The analysis at hand concerns itself with the flow of money and the dynamics money brings in the circular movement. In an economy, income and expenditure is measured using money. The circular flow of income and the expenditure bases on two perspectives, the macro and the microeconomics. The circular flow of income and expenditure are two of the greatest depictions of a how an economy is fairing realistically. The circular flow of income and expenditure anchors from three distinct sectors in any given economy. The sectors are households, banks or financial institutions and firms. Therefore, it means that income, expenditure flows in a circular motion from each of the sectors to the next, and this is irrespective of whether the analyst looks at it from a microeconomic or macroeconomic point f view. In this light, it is pertinent for an elaboration of the two perspectives. First, the microeconomics concerns with the various individual aspects in an economy. The individual aspects that give a reflection of the concept of circular flow of goods and services are those that focus on the individual components of an economy. The components include individual firms, households, prices, wages, and incomes. On the other hand, the macroeconomics perspective focuses on all the key components related to the aggregate components whose influence to an economy is collective. Circular Flow from a Microeconomics Perspective Just as mentioned above, microeconomics is fundamentally concerned with the explanation of individual components and players in any given economy. For this reason, the circular flow of income and expenditure in this section bases on individual components. The circular flow of income and expenditure explained in microeconomic perspective needs one to assume an individual firm, household and bank, in three-sector economy. In a three-sector economy, the concern in a analyzing a firm is about how that firm makes money and how it expenditure patter looks like. The same is also the concern when assessing both a household and a firm. Each of the three sectors selected for purposes of this analysis will look at vetting firms to ascertain their way of attaining equilibrium. First, any individual firm operational in an economy, there is a way it decides its production. The other important aspects are how the firms cuts costs and what it produces. The decisions, explain that firms role in the circular flow of income and expenditure in a microeconomic perspective. The only way that the whole concept easily fits into perception is by narrowing down to specifics. Therefore, what that means is that, in a three-sector model, the assumptions are that the firm should have no resources of its own, it should hire all factors of production and the goods only be sold to the households. Further assumptions on this case are that there should be no corporate saving or but borrowing and deposition in bank is present. On the part of households, the depiction is more realistic and the assumptions here are more realistically painted. The households consume the goods and services from firms and they own all the factors of production. The aggregate income for the households will consist of rent, interest, wages and profits. The households save portions of their incomes and hence they are in position of supplying firms with the finances they need. Furthermore, there is the presence of government and the role it plays in the economy reduces to the control of only three variables. The variables here are the direct taxes collection, government spending and the transfer of payments. The variables have a distinct effect on the economy as a whole. The assumption is that there is no foreign sector in the case, this looks at reduction of constraints. The interaction between the three key sectors in the economy assumed in this case is intricate (Lloyd, 3). Principally, an individual household has all its income from either the wages and salaries from the labor engagements that it provides at the firm. All other additional income for that particular household comes from renting the other factors of production to the firm. The rent paid to the household is a factor payment and made as a compulsory payment for the rent of the factor of production, which in this case is the rented premise owned by this household. The household do have a significant proportion of its expenditure spent on other commitments. The household pay direct taxes to the government. Secondly, the household pay for the goods and services that it consumes in its daily sustainability. The other expenditure on the part of the household is that which goes out to service and improve the factors of production it rents to the firm. For example, the premises the firms rent from the households need maintenance and that is a substantial expenditure on the part of the households (Lloyd, 2). The household pays a property tax to the government for holding the firm. The tax is part of the governmental commitment that has to place on the household in a bid to avoid the over circulation of money on the economy and in curbing spending. The firm has its own share of circular flow of income and expenditure well depicted by its interaction with the firm. The interaction shows that that there is a role played by the firm too in the economy. The firm takes a significant income away from the household. The income it takes from the firm enables it to fund the production of goods and provision of services to the household. The government takes a direct tax form the firm and from the household. The direct tax gives the government a fund from which it is able to pay a subsidy to the firm and transfer payment to the household. The government provides social amenities to the firm and to the household from the tax paid by the two key players in the economy. The firm gets an income by selling goods and services to the households. The firms still make some income from the government purchases and government subsidies, a reserve of the firms. The government offers these subsidies as way of keeping them in operation even in cases where the households increase the cost of the factors of production. The expenditure on the part of the firm includes the rent payments on the factors of production. The firm pays for the labor and the premises the firms occupy. These payments end up being in the coffers of the households and the government. Circular Flow from a Macroeconomics Perspective A conceptual model diagram indicating the circular flow of income and expenditure First, the household have all their incomes from wages and salaries from the labor they provide to firms. Additional income for the households comes from renting the other factors of production to the firms. The rent paid to the households is referred to as factor payments. The households do have some portion of their expenditure spent on other commitments. The households pay direct taxes to the government. Secondly, the households pay for the goods and services that they consume in their households. The other expenditure on the part of the households is that which goes out to service and improve the factors of production. For example, the premises the firms rent from the households need maintenance and that is a substantial expenditure on the part of the households. The firm’s circular flow of income and expenditure well depicted in the above diagram (1.1) shows that that there is a role played by the firm too. The firm gets an income by selling goods and services to the households. The firms still make some income from the government purchases and government subsidies, a reserve of the firms. The government offers these subsidies as way of keeping them in operation even in cases where the households increase the cost of the factors of production. The expenditure on the part of the firm includes the rent payments on the factors of production. The firm pays for the labor and the premises the firms occupy. These payments end up being in the coffers of the households and the government. The government is the controller of the economy and in this scenario, it is evidenced in the governmental role of collection the direct taxes. The taxes come from the households and the firms who in this case are representative of a functioning economy. The taxes collected by the government serve as income. On the other hand, the government, it is vital to note that the microeconomics concerns with the various individual aspects in an economy. The individual aspects that give a reflection of the concept of circular flow of goods and services are those that focus on the individual components of an economy that in this case point out the unique relationship between the economy and the government. The components include individual firms, households, prices, wages, and incomes. On the other hand, the macroeconomics perspective focuses on all the key components related to the aggregate components whose influence to an economy is collective (Antoin, 242). Works Cited Lloyd A. Metzler. “Three Lags in the Circular Flow of Income”, in: Income, Employment and Public; essays in honor of Alvin H. Hansen, Lloyd A Metzler; New York, W.W. Norton [1948]. pp. 11-32 (2013). Antoin E. Murphy. "John Law and Richard Cantillon on the circular flow of income." Journal of the History of Economic Thought. 1.1 (1993): 47-62. Sloman, John Economics, 3rd edition. Prentice Economics. Europe: Prentice-Hall. ISBN 0-273-65574-4. (1999). Read More