Circular Flow of Income
is a model which illustrates the flow of resources, goods and services and money between different sectors of the economy.
Assumptions of the Simple CFofY (3)
- There are only 2 sectors: households and firms
- All income earnt is spent on G&S
- Households are the owners of resources
Households
are the owners of the productive resources, land, labour, capital and enterprise, and are the buyers of goods and services.
Firms
are the employers of resources and produce all goods and services for the economy.
Real Flow
This flow consists of real, tangible things, being resources from households, which is then exchanged for real, tangible things from firms which are goods and services.
Money Flow
The flow of money exchange, being income from firms and consumer expenditure from households.
Financial Sector
Consists of all financial institutions, for example banks and credit unions. These financial institutions act as an intermediary or middleman between savers and investors.
Assumptions of the 3 Sector CFofY
- There are 3 sectors in the economy; households, firms and the financial sector
- All income is either spent or saved:
Y = C + S
Savings
The portion of income not spent on goods and services for current consumption. In the circular flow of income model it can be seen as a leakage, reducing the flow of income in Australia.
Investments
Expenditure on producer or capital goods that are, not intended for current consumption, but used to produce final goods and services in the future by Firms. In the circular flow of income model it can be seen as an injection, meaning it improves the flow
Leakage
Money that leaves the economy, reducing the flow of money.
In the full circular flow of income model savings, taxation and imports represent leakages as money leaves the economy to go to a particular sector.
Injection
Money that enters the economy to increase the flow of money.
In the full circular flow of income model investments, government spending and exports represent injections as each sector injects money into the economy.
Government Sector
Sector that collects taxation from households mainly through income tax, with some then being injected back into the economy in forms such as welfare, subsides and health care.
Overseas Sector
Compromises of individuals, governments and firms that are overseas
Imports
are transactions in which money flows from Australia to overseas as an Australian resident purchases a good or service made overseas.
Exports
are transactions in which the money flows from overseas to Australia as overseas residents purchase goods and services made from Australia.
Aggregate Expenditure
Total spending in the economy by all sectors.
AE = C + I + G + (X - M)
Factors Affecting Consumption Spending (C)
DIGEWO
Disposable Income (Yd)
Interest rates (r)
Government policies
Expectations
Wealth/Stock of wealth
Other: Availability of credit
Monetary Policy
is when the RBA changes interest rates
Fiscal Policy
is changes to the government budget,
i.e. changes to government spending or taxation
Factors Affecting Investment Expenditure (I)
GRIPE
Government Policies
Risk
Interest Rates
Profitability
Expectations (Business)
Factors Affecting Government (G)
Discretionary Changes
Automatic Stabiliser
Factors Affecting Net Exports (X-M)
PEET
Protection
Exchange Rates
Economic Performance (domestic & overseas)
Terms of Trade