National Income and Social Accounts— (Circular Flow of Economic Activity—Two Sector Model—Household and Business Sectors—Three Sector Models including Government Transzc- tions—Four sector op2n Economy Mavel inclu sing Foreign Trade Transac tions—Macroeconamic Snort Period Static Equilibrium—Conclusions] Circular Flow and Economic Activity It means continual circular movement of money and goods in the economy. The concept the circular flaw of income is a simplification which attempts to Mlustrate the flow of monay and goods from households to business: je and back to households. We know that the economic ai jouseholds may be taken as one sata because their activities are more -or less of the same type. Enterprises and government agencies too.caneach_ . Be grouped also, Through economic activity (production, consumstion, Capital formation etc.), these groups are linked up not only with each other ‘But also_with_other_economies- problems of the world—by flow of goods ; ake @ circular flow of economic le see that GNP, GNY and GNE are all identical in values and when depreciation is deducted, they become net—/. e, NNP=S=NNYSNNE, (the symbol=denotes identity). But the income, output and expenditure approach would not assume such a great importance if they were merely identical to each other; the fact of the matter is that income outout and employment are equal to each other functionally also,KEYNESIAN E 2 éuction units. They vay them (to factors) in the form of wa 2 Interest and profits. This forms the imcome o ‘spent, ‘Thas. the functioning of the economy consists in the prosuc: ‘coads and ine services by the factors of production and production unit sf Whaj are ‘cost, to business. are “incomes, to the factcrs such 23 they y workers and the resource-owners. Consumers expenditure is income to business. “Wt is expenditure by the Consumers that determines the income = \ More expenditure means more income and gree'er a mings of the factors and their spendings Ghd =5 on, Once we understznd this, we understand the circular flow of . Keynesisn aosrozch of income eiso tells us the most important cofdition wnich must be fulfilled befofe the economy in ecuiibeiur, 7. €., the important condition of saving being equal to invest- ~ ment We ton that in a closed economy with no government activity the income (Y) divided between consumption expenditure (Cj) and invest- ment excenditure (). We also know that whatever part of income is not consumed is saved (Y=C+S), Since income (Y) = Expenditure (E), there- fore, C-S=C +I: theretore, S=/. Herein lies the greatest importance of Keynesian approach. In tie fundamental Keynesian equation Y=C-1,C cepende on Y. therefore. it is essential to understand clearly wnat ¥ stands for ard what different concepts ate that have come to lie ass Keynes. Today, 2:3, (ne _of the im; anificent. tant conditions for the economy to be in equili- _Sezcias oF the exanomy m Storm nce ne (7) By the FJ—this 13 the incom2-expenditure Epon, in wich tne oslance between the two sides is maintained — when tis is done, it is s3id tnat the ciscular flow of economic activity has been maintained and the economy is in a state of macro eq - This citculas flow of economic activity is maintained not only in two sen coved simple economy but also in three sector economy and four tenn Open economy in With ve take Into Consideration ihe foreign wade tein wansentions. In order to altain the circular flow of economic activity DeAeaay aa jastranie of trarsections in the various sectors cf the economy “ae mate Creat Mou 1165361 nighligh's the circular flow of spending and nein _betneen business and bouschold sectors of the ¢onomy built on thie concent that spancing creates income. an ‘yw 5 Tao Sector . v ex 5 In_4 two-sector model of a simple economy we consider Household Household own all economichad INCOME AND SOCIAL ACCOUNTS-IL (Cy Vv 8 an either labour force source oF factors of pro upilony Those resduTt a U turn provide them with known as real flows.) By themselves these real flows would mean parter— * money—the medium of jut this being very inconvenient—we make use o| se of scarce economic exchange. Business sector gives money for the purcha: id also receive money in return for fiom the resource markets_ani ervices produced and supplied _throug! 5 for factor services and incur—what are_called return, Thus, flows of gcods and The flows of money in the “4 RESOURCE, MARKETS RESOURCES HOUSEHOLD goons & SERVICES phoouct a \aner , y|_/ MANKETS a Civertt iT X Coa\ten Loops) s. By Ay yanthe resource and product markets. In other words, all the economic resources directly from the households; Two Serldy Ms J olds buy goods and services directly from businesses. Both types o jor do the house- KBYNESIAN ECONOMICS & transactions are carried through the Markets (the resource market and the Product market). Starting ftom the resource duction_ard_in the process supplies oa ae and services through Product market (Box Til) to households je Satisfaction of their markets ( (Box | ) household ¢ The medel depicts circular flow in two sector simple economy, where household sector earns Rs. 10,000 from the sale of ‘factor services’ to busi- ness sector and this business sector makes use of these inputs to produce an output in the economy exactly equal to Rs. 10.000. The basic assumption being that income payments to business sector for factor services return to business sector in the form of purchase of output of fina/ goods and services—the circular of income and product not only maintains itself but tends to perpetuate itself, production equal sales—output equals demand— and there will be a tendency to continue operating at the same level—the whole process being described as macroeconomic short period static equilibrium. Accordingly, the economic agents in the business sector are called ‘producers’ and economic agents in the household sector are called ‘consumers’. As such there are mainly two broad types of transactions that take place between ‘producers’ and ‘consumers’. From the viewpoint of producers these transactions take the form of, (i) purchase of the factor services from the household sector, (ii) sale of final output to household sector, From the ‘consumers’ viewpoint, these transactions take the form of, (i) sa/e of factor services to business sector, (ii) purchase of final output from business sector. The circular flow of economic activity in the two sector simple economy is, however, based on the following assumptions : mpPrunations t a (a)_The economy is a closed economy (no foreign trade sector), py Praduction takes place only in business sector, “AclProducers sell_all_ that they produce. In other words, there is no inventory accumulation in the business sector, ( _Vo a NATIONAL INCOME AND SOCIAL ACCOUNTS It */ (consumers spend all their income on consumption. In other words, a there is no saving in the household sector, 7. eee ‘are no transactions involved like government expenditure "on goo ices or taxes etc. SEeaoTs To UDOT These ‘assum nces thamain- omplications in our si @ or model of the economy described above. These complications flow; while leakages are factors which tend to reduce vanism of circular flow remains the same though some adj fom tions will have to be made. ven in two Sector model based on simple assumptions mentioned above there may be leakages form the income stream in the form of savings by the household sector. They may save a fraction of income say, Rs. 1000/- out of Rs. 10,000 (in the above example) and decide not to spend—as a resuit consumption expenditure will fall to Rs. 9000. But as the business sector is producing output worth Rs. 10,C0)—there will be unintended accumu- lation of goods worth Rs. 1090 called unwanted inven:ories. This will x interrupt the circular flow because business sector is still producing worth Rs. 10,000 and all that can be sold is worth Rs, 9,000—so production levels will have to be cut back in the second round, reducing, in turn, the flow of income to household sector. It shows that leakages in any form would reduce the production and income level and would also interfere with the x smooth flow of circular activity. However, should the business sector decide to buy the leftover output wortn Rs. 1000 for any reason (because it wishes to add to its stock of inventories) total expenditure can still remain equal to output despite the saving leakage. Thus, if intended or desired business investment equals saving—equilibrium flow can still be maintained at the original level of income and output. This is shown in the model given on page 84, The model shows that the household sector saves Rs. 1000 and spends Rs. 9000 on consumption—business sector purchases goods and services worth Rs. 1000 for its own use, theraby helping the economy to maintain the circular flow. But the model shows that there is a capital market also between S and / flows. Just as factor services or resources flow through resource market and the final output through product market S and / flow through capital market. According to classical capital market always acted in a manner that will make saving equal to investments automatically trong, me Acne of the rate of interest. But modern economistsNATIONAL INCOME AND SOCIAL ACCOUNTS-It circular flow. jen these flows are added in our four sector model we rggpimpors as leakages and Sime as_injections, y must equal total aTeatOnS fowever, in the four sector open model leakages would consist of imports besides savings and taxes and jections would consist of exports besides investment and government expenditure. J In the symbolic form the four sector model of circular flow can be shown as follows: . . Let us put MWP=Y, consumption expenditure including imports = C. intended investment=/, government purchase of goods and services= exports =X, and imports=Z. The supply of output available to an economy consists of its domestic production (VP of ¥ plus the level of imports (Z). In macroeconomic equilibrium condition when circular flow is maintained this Supply must exactly equal the sum of demands of the household, business, government and foreign trade sectors for exports (denoted by X). C As such we may rewrite the condition: Z+V=CH+I+G+X or Y =C+I/+G+ (X—Z) Where X~ Z represents the net trade balance (the difference between exports and imports). Denoting savings by S and taxes by 7 and net disposable income of households by Y,— we rewrite the above equation as follows : Y=Y,+T (But Yq can be either spent on C or saved, we get) \ Y=C4+S4T7 ("4 Ya=C+S) e fore, C4847 = C+/I4G4+X—Z or S+T4+2=/4+G4X.Ipprere ome & es hth Me | gpensbnf Pi FOREIGN SECTOR FINANCIAL SECTOR LEAKAGE ~ SAVING: Leaxade = maponts wsteu10N INJECTION - INVESTMENT EXPORTS HOUSEHOLD SECTOR Fig. 7 This model shows the varlous kinds of transactions which originate and take place In different sectors of the economy and cause complications “at once the necessary, adjustments between leakages and injections like saving end_investment in two sector model—taxes and government expenditure in three sector model and imports and exports in four sector model_are made—the circular flow of economic activity of the macro ~ static eguiibrivn is obtained irre! ive of the fact whetherATIONAL INCOME AND SOCIAL ACCOUNTS-IL 89 MAIN IDEAS 4. Circular flow implies a continuous movement of money and gocds in the economy. 2. One of the most important condi circular flow must be maintained. 3. The circular flow is first of all maintained in two sector simple and closed economy. 4, Two sector model comprises of the Household sector ana the Eusiness sector. 5. The circular flow in two sector is at-ained when production equals sale end output equals demand. 6 When govern nent sector involving government transactions are involved it is calied three sector model & for circular flow certain adjustments in the transactions are made. 7. When the transactions involving foreign trade are taken into account like imports and exports—it is called four sector model ofan open economy and the necessary adjustments amongst leakages (imports) and injections (exports) are made before the circular flow is maintained in such an economy, ibrium is that its ns of macroeconomic eq