But typically the government then uses this money to engage in the injection into the economy described above. Members of households pay for goods and services they consume with the income they receive from selling their factor in the relevant market. Factors of production earn an income which contributes to national income. Land receives rent, human capital receives a wage, real capital receives a rate of return, and enterprise receives a profit. Similarly, some of the goods consumed in our economy are not produced locally. For example, suppose that a US restaurant chain purchases Argentine beef.

If we export more than we import, then—on net—we are lending to the rest of the world, and there is a flow of dollars from the financial markets to the rest of the world. This detailed guide should provide a comprehensive understanding of the circular flow of income model, its components, and its application in real-world economies. The 2 Sector Model of Circular Flow is sometimes called the Basic Model or the Closed Version. The two sectors include households (private citizens) and firms (private businesses). The Circular Flow of Income (CFOI) is a model showing the flow of goods, services and factors of production between economic agents within an economy. Tax (T) is the revenue of the government that is received from people and firms.

Circular Flow of Income

This model provides a foundation for understanding the interactions between different sectors of an economy and helps identify the impacts of various economic policies. In this article, we will explore the key components of the circular flow model and discuss its importance in understanding how the economy functions. Injections mean the addition or introduction of income to the circular flow of an economy.

Importance of Circular Flow Diagram

The money spent on imports is leakage and is an activity of the foreign sector. Government spending (G) is the spending of the government on public projects. Government spending is an injection and is the activity of the government sector.

Exports (X)

1. In short, the market for goods and services is simply where the goods and services produced by businesses are bought.
2. The three different phases in a circular flow of income are Generation, Distribution, and Disposition.
3. The government sector is made up of economic activities by the municipal, state, and federal governments.
4. When leakages are equal to injections, the national income is said to be in equilibrium.
5. In this case, our economy is lending to the rest of the world and acquiring more assets.

The explain circular flow of national income with five sector model amount that the government collects in taxes does not need to equal the amount that it pays out for government purchases and transfers. The outer flow starts from the firms that pay rewards for the factors of production to the households in the form of rent, wages, interest, and profit. This income is spent by households in the form of consumption and becomes the revenue of firms. This money can be in the form of the income and spending of households and firms. The outer circle is anticlockwise and is represented by red arrows in the above diagram. The inner flow starts with the households that provide factors of production to firms through the factor markets.

The three different phases in a circular flow of income are Generation, Distribution, and Disposition. Saving (S) is the portion of household income that is not spent but kept aside for future use. Saving is a leakage and is the activity of the household sector. For example, at the diner, revenue comes from customers paying for their food.