Circular Flow of Income in Economy

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Questions and Answers

What is the economy defined as?

A system of production and exchange

A system of exchange only

A system of consumption only

An integrated system of production, exchange, and consumption (correct)

The flow of goods and services is in the same direction as the money flow.

False

What are the two kinds of flows generated by economic transactions?

Product or real flow and money flow

The household sector provides firms with _______________________.

labour and other factors of production Signup and view all the answers

Match the following sectors with their descriptions:

Household sector = Provides labour and other factors of production Business / Firm sector = Produces goods and services Government sector = Regulates economic activity Foreign sector = Trades with other countries Signup and view all the answers

What is the Two-sector model composed of?

Household and Business sectors Signup and view all the answers

The Circular Flow Diagram illustrates the linear flows of income and expenditure.

False Signup and view all the answers

What determines the size of national income?

The magnitude of the circular flows of factor incomes and expenditure Signup and view all the answers

What do firms make to households as?

Rent, wages, interest, and profits Signup and view all the answers

There is an inflow or outflow of income or goods and services from outside sources in the circular flow model.

False Signup and view all the answers

What is the term economists use to describe the wages plus other forms of income?

National income Signup and view all the answers

The magnitude of income and expenditure flow is determined by the size of the society's ______________.

income and expenditure Signup and view all the answers

What is an example of a withdrawal in the circular flow model?

Households setting aside income for old age Signup and view all the answers

Savings are always a form of injection in the circular flow model.

False Signup and view all the answers

Match the following components with their roles in the circular flow model:

Households = Sell factor services to firms and receive income Firms = Sell goods and services to households and receive income Factor markets = Households receive factor services from firms Goods market = Households purchase goods and services from firms Signup and view all the answers

What is the term used to describe the concept of households and firms setting aside income and not spending it on domestically produced goods and services?

Withdrawals Signup and view all the answers

What is the primary function of the foreign sector in the economy?

To receive income from the business sector for imports Signup and view all the answers

If imports exceed exports, the economy has a surplus balance of payment.

False Signup and view all the answers

What happens to the excess income of the household, business, and government sectors?

They deposit their excess income to the capital markets as savings. Signup and view all the answers

The ______________ sector receives income from the business sector for imports.

foreign Signup and view all the answers

Match the following sectors with their primary functions:

Household = Deposits excess income to capital markets as savings Business = Borrows savings from capital markets for investments Government = Regulates the economy and provides public goods Foreign = Receives income from business sector for imports Signup and view all the answers

Study Notes

Circular Flow of Income

An economy is an integrated system of production, exchange, and consumption involving transactions between individuals, generating two flows: product/real flow (goods and services) and money flow, which move in opposite directions.
Product flow consists of factor flow (factor services) and goods flow (goods and services).
In a monetized economy, factor payments generate money flow, which is spent on consumer and capital goods, forming an expenditure flow.

Circular Flow Models

The economy is divided into four sectors: Household, Business/Firm, Government, and Foreign.
Three models illustrate the circular flow of income and expenditure:
- Two-sector model: Household and Business sectors
- Three-sector model: adds Government sector
- Four-sector model: adds Foreign sector

Sector Interactions

Household sector: provides factor services, receives income, and spends on goods and services.
Business/Firm sector: pays factor incomes, produces goods and services, and spends on capital goods.
Government sector: receives taxes, spends on goods and services, and provides public goods.
Foreign sector: imports and exports goods and services, affecting the balance of payments.

Leakages and Injections

Withdrawals: amounts set aside by households and firms, reducing the circular flow (e.g., savings, provision for old age).
Injections: amounts added to the circular flow (e.g., investments, government spending).
Savings can be a withdrawal, but when spent, it becomes an injection.