Question

In a 1-2 page paper develop the concepts of the “circular flow” of goods and services. Begin by reviewing this video: Circular Flow from the St. Lois Federal Reserve. A transcript is available for the hearing impaired. Then, select one good you are familiar with. Describe how the good moves in relation to: Households Suppliers of goods and services Money Be sure you have presented your assignment in a logical format, that has an introduction paragraph, the body (one or more paragraphs), and a concluding paragraph

Answer 1

The circular flow of economic activity is a model showing the basic economic relationships within a market economy. It illustrates the balance between injections and leakages in our economy. Half of the model includes injections, and half of the model includes leakages. The circular flow model shows where money goes and what it's exchanged for. The model includes households, businesses and governments. We also have the banking system that facilitates the exchange of money and, as we'll see in a minute, helps to productively turn savings into investment in order to grow the economy. In the circular flow of the economy, money is used to purchase goods and services. Goods and services flow through the economy in one direction while money flows in the opposite direction.

The factors of production include land, labor, capital and entrepreneurship. The prices that correspond to these factors of production are rent, wages and profit. People in households buy goods and services from businesses in an attempt to satisfy their unlimited needs and wants. Households also sell their labor, land, and capital in exchange for income that they use to buy goods and services that firms produce. Businesses sell goods and services to households, earning revenue and generating profits. Businesses also pay wages, interest and profits to households in return for the use of their factors of production. Governments levy taxes on households and businesses in order to provide certain benefits to everyone.

When you look at the circular flow model more closely, you find that there are things that inject money into the economy and other things that leak out of the economy. Injections into the economy include investment, government purchases and exports while leakages include savings, taxes and imports.

Savings leaks out to borrowers as it goes through the banking system, and borrowers use the money to buy goods and services, which then injects the money back into the circular flow. Government taxes leak out of the circular flow model, and then government spending injects them back into the economy. Imports leak out of the economy because the money in our country that's used to buy imports from other countries goes out of our economy and into their hands. Exports, on the other hand, are an injection because we earn income from the goods and services we export to other countries.

Households are consumers. They may be single-individuals or group of consumers taking a joint decision regarding consumption. They may also be families. Their ultimate aim is to satisfy the wants of their members with their limited budgets.

Households are the owners of factors of production—land, labour, capital and entrepreneurial ability. They sell the services of these factors and receive income in return in the form of rent, wages, and interest and profit respectively.

The term firm is used interchangeably with the term producer in economics. The decision to manufacture goods and services is taken by a firm. For this purpose, it employs factors of production and makes payments to their owners. Just as household’s consumer goods and services to satisfy their wants, similarly firms produce goods and services to make a profit.

The term ‘firm’ includes joint stock companies like DCM, TISCO etc., public enterprises like IOC, STC, etc., partnership concerns, cooperative societies, and even small and big trading shops which do not manufacture the commodities they sell.

The government plays a key role in all types of economic systems—capitalist, socialist and mixed. In a capitalist economy, the government does not interfere. It simply establishes and protects property rights. It sets standards for weights and measures, and the monetary system.