Q.6 Explain the terms withdrawals and injections. OR “The magnitude of withdrawals and injections will expand or contract size of circular flows”. Examine.

Ans : A careful study of the circular flow models will reflect (reveal) that certain flow variables act like injections into the economy while certain others act like withdrawals. WITHDRAWALS (LEAKAGES) : Withdrawals are the amount of money which is withdrawn from or leaked out of the regular economy. Withdrawals reduce the size of circular flows of income and expenditure because it takes away some money from regular economy (and this money does not come back to the circular flows of income and expenditure) which is not available for spending on currently produced goods and services. Withdrawals have negative impact on process of production or process of income generation in economy. Therefore, withdrawals dampen the speed of economic activities and bring down the growth of national income. INJECTIONS (ADDITIONS) : Injections are the amount of money which is added into regular economy. Injections raise the size of circular flows of income and expenditure because it adds some money into regular economy which is additionally available for spending on currently produced goods and services. Injections have positive impact on process of production or process of income generation in economy. Therefore, injections boost the speed of economic activities and bring up the growth of national income.

[A] Withdrawal and Injection in a Two –Sector Model : Withdrawal : In a two-sector model, a withdrawal is the amount that is set aside by the households and firms and it is not spent on domestically produced goods and services over a period of time.

For example,

-- Households set aside a part of their income as a provision for old age or as a provision against the loss of job.

-- Firms may also withhold (set aside) a part of their receipts in anticipation of depression. The saving is withdrawal.

It does not come back to circular flows of income. Therefore, withdrawals reduce the size of circular flow. Injection : On the other hand, in a two –sector model, an injection is the amount that is spent by households and firms in addition to their incomes generated within the regular economy. For Example, -- Households make injection of money when they spend from inherited savings, own hoardings or by borrowings. -- Firms also make injection of money when they spend by borrowing from outside of the model economy. The investment is one type of injection. It adds some money to circular flows of income. Therefore, injections raise the size of circular flow. The withdrawals and injections in a two –sector model are shown in following figure : The lower half of figure shows the withdrawals and injections by the households. And the upper half of figure shows the withdrawals and injections by the firms.

[B] Withdrawal and Injection in a Three –Sector Model : Withdrawal in the Form of Tax (T) : In a three sector model, taxes are withdrawals. When government imposes direct taxes on households and firms, and also various types of indirect taxes in economy, it will reduce

-- disposable income and consumption of households,

-- sales and income of firms,

-- production and investment in the economy, and

-- size of the circular flow.

Injections (G) :

(a) GOVERNMENT EXPENDITURE : Government expenditure is an injection to the circular flows. Because it adds to the aggregate demand. Here, government purchases factor services from the households and goods and services from the firms.

(b) TRANSFER PAYMENTS : The transfer payments by the government (e.g. old age pension, unemployment, allowances, subsidies, etc.,) are injection to the circular flows. They add to the income of households who raise demand for consumer goods.

Net Effect of T and G : Thus, T is withdrawal and G is injection. Net effect of T and G on size of flows depends on whether T and G are equal or not. Budgetary policy of government determines whether tax revenue and government expenditure are equal or not.

 If government adopts a balanced budget policy, then G = T.

 If government adopts a deficit budget policy, then G > T.

 If government adopts a surplus budget policy, then G < T.

The balanced and deficit budget policies indicate injections into economy. So, they expand circular flows. On the other hand, a surplus budget policy indicates withdrawal from the economy. So it reduces size of circular flows.

[C] Withdrawals and Injections in a Four –Sector Model : Withdrawal in the Form of Import (M) : In case of imports, there is -- inflow of goods and services into the economy, and, -- outflow of money (foreign exchange) in the form of “payment for imports” from the economy. This is the flow of expenditure out of the economy.

Thus, imports (M) represent withdrawals from the economy. Injections : (a) Exports (X) : In case of exports, there is

-- outflow of goods and services from the economy, and

-- inflow of money (foreign exchange) in the form of “receipts from export” into the economy. This is the flow of foreign incomes into the economy. Thus exports (X) represent injections into the economy.

(b) Export of Manpower (X) : In case of export of manpower, there is

-- outflow of manpower from the economy, and

-- inflow of money in the firm of foreign remittances into the economy. This is another flow of foreign income as an injection into the economy. Net Effect of foreign trade i.e. X and M : The effect of foreign trade on magnitude of circular flows depends upon trade balance. Trade balance is defined as X – M. If X > M, inflow of foreign income is greater than outflow of money (expenditure). There is net gain from foreign trade. This increases the magnitude of circular flows. But if X < M, inflow of foreign income is less than outflow of money (expenditure). There is net loss from foreign trade. This reduces the magnitude of circular flows. And If X = M, inflow of foreign income is equal to outflow of money (expenditure). There is no net effect from foreign trade. The magnitude of circular flows remains unchanged.

OVERALL EFFECT : It is very important to understand and consider the overall impact of all withdrawals such as saving (S), Tax (T) and Import (M) as well as all injections such as Investment (I), Government Expenditure (G) and Exports (X). The flow of national income remains stable and also in equilibrium when the injections are just equal to the withdrawals. Therefore, the equilibrium condition for the size of flow of national income is as under. Total Expenditure (E) = Total Income (Y) C + I + G + X = C + S + T + M OR I + G + X = S + T + M OR All Injections = All Withdrawals OR (I – S) + (G – T) + ( X – M) = 0.

The equilibrium level of income is determined when total withdrawals are equal to total injections. If there is difference between withdrawals and injections, there are fluctuations in the flow of income.

 If withdrawals are less than injections i.e. if S + T + M < I + G + X, then the expansionary process begins and income level rises in the economy. As a result of this, S , T and M go up. This process continues till the withdrawals once again become equal to injections.

 If withdrawals are more than injection i.e. if S + T + M > I + G + X, then contractionary process begins and income level falls in the economy. As a result of this, S, T and M come down. This process continues till the withdrawals once again become equal to injections.

DIFFERENCE BETWEEN WITHDRAWALS AND INJECTIONS :

1. Withdrawal is the amount of money which is withdrawn from or leaked out of the regular economy. 1. Injection is the amount of money which is added or injected into the regular economy.

2. It reduces the size of the circular flow of income as it takes away some money from the regular economy

2. It raises the size of the circular flow of income as it adds some money into the regular economy.

3. It is not available for spending on currently produced goods and services in economy

3. It is additionally available for spending on currently produced goods and services in economy

4. It has negative impact on process of production and generation of income

4. It has positive impact on process of production and generation of income.

5. It dampens the speed of economic activities

5. It boosts the speed of economic activities.

6. It brings down the growth of national income.

6. It brings up the growth of national income

7. Savings, Taxes and Imports are the examples of withdrawals

7. Investment, Government expenditure and exports are the examples of injections.

8. Excess of withdrawals over injection create contractionary process in the economy.

8. Excess of injections over withdrawals create expansionary process in the economy.

REAL FLOW AND MONEY FLOW :

Q.5 Write a short note on real flow and money flow.

Ans :

REAL FLOW :

Real flow is also known as “Physical Flow”. Real flow refers to the flow of factor services from households to firms and the corresponding flow of goods and services from firms to households. Real flow refers to product flow and factor flow. In product flow, there is a flow of goods and services from firms to households. In factor flow, there is a flow of factors of production like land, labour, capital and entrepreneurship from households to firms.

MONEY FLOW :

Money flow is also known as “Nominal Flow”. Money flow refers to the flow of factor payments (incomes) from firms to households for their factors services and the corresponding flow of consumption expenditure from households to firms for purchase of goods and services produced by firms. Money flow refers to income flow and expenditure flow. In income flow, households get factor incomes (in the form of rent, wages, interest and profit) from the firms as they provide factor services (land, labour, capital and entrepreneurship) to the firms. In expenditure flow, households make consumption expenditure on goods and services produced by the firms. From the above discussion it can be concluded that real flow consists of real macro variables such as goods and services as well as factor services. Similarly, money flow consists of money macro variables such as factor payments and consumption expenditure. Real flow and money flow more in opposite direction. And these two flows are related with each other as shown in following figure : Household Sector Business Sector Factor Services Goods and Services Household Sector Business Sector Factor Payments Consumption Expenditure Household Sector Business Sector Factor Services Consumption Expenditure Factor Payments Goods and Services

DIFFERENCE BETWEEN REAL FLOW AND MONEY FLOW :

Real Flow Money Flow

1. It consists of factor flow and product flow 1. It consists of income flow and expenditure flow
2. It involves exchange of factors of production and goods and services 2. It involves exchange of money in the form of factor payment and consumption expenditure 3.
It applies to a barter economy 3. It applied to monetized economy
4. Difficulties of barter system are involved in case of real flow 4. No such difficulties are involved in case of money flow .
It is also known as Physical Flow 5. It is also known as Nominal Flow WITHDRAWALS AND INJECTIONS :

CIRCULAR FLOWS OF INCOME AND EXPENDITURE WITH FOREIGN SECTOR: A FOUR-SECTOR MODEL :

Q.4 Explain circular flows of income and expenditure in a four-sector model.

Ans: The four-sector model is formed by adding the foreign sector to the three-sector model.

The foreign sector includes two types of international transactions :

(i) Foreign Trade i.e. export and import of goods and services, and

(ii) Inflow and Outflow of capital.

For the purpose of simplicity, we make the following assumptions :

(a) The foreign sector includes only exports and imports of goods and services;

(b) Only firms make exports and imports of goods and non-labour services; and

The four-sector model is shown in the following figure :

Exports (X) [ Injection ]:

In the case of exports, there is

-- outflow of goods and services from the economy, and

-- inflow of money (foreign exchange) in the form of “receipts from export” into the economy.

This is the flow of foreign incomes into the economy. Thus exports (X) represent injections into the economy.

IMPORT (M) [WITHDRAWAL]:

In the case of imports, there is

-- inflow of goods and services into the economy, and,

-- outflow of money (foreign exchange) in the form of “payment for imports” from the economy.

This is the flow of expenditure out of the economy. Thus, imports (M) represent withdrawals from the economy.

EXPORT OF MANPOWER [INJECTION]:

The households export manpower to the foreign sector. In return, they get foreign remittances in terms of foreign exchange. This is another inflow of income into the economy. So it is injected into the economy.

Effect of Foreign Trade :

The effect of foreign trade on the magnitude of circular flows depends upon the trade balance. The trade balance is defined as X – M

If X > M, the inflow of foreign income is greater than the outflow of money (expenditure). There is a net gain from foreign trade. This increases the magnitude of circular flows.

But if X < M, the inflow of foreign income is less than the outflow of money (expenditure). There is net loss from foreign trade. This reduces the magnitude of circular flows.

And If X = M, the inflow of foreign income is equal to the outflow of money (expenditure). There is no net effect from foreign trade. The magnitude of circular flows remains unchanged.

The Equilibrium Condition :

 The total expenditure (E) of the economy is the sum of consumption expenditure(C), Investment(I), Government expenditure(G), and, Exports(X). Symbolically, E = C + I + G + X ….(I)

 The total income (Y) received is allocated between Consumption(C), Saving(S), Taxes(T) and Imports(M). Symbolically, Y = C + S + T + M …. (ii)

 If total expenditure (E) is equal to total income(Y) received, (i.e. E = Y), then C + I + G + X = C + S + T + M …(iii)

 The term C is common on both side, therefore C is cancelled out. Therefore, I + G + X = S + T + M …(iv)

The equation(iv) clearly says that injections such as investment expenditure(I), Government expenditure(G), and Exports (X) are equal with total withdrawals such as Savings(S), Taxes(T) and Imports(M). Thus, re-arranging the equation (iv) we have, (I – S) + (G – T) + (X – M) = 0

The equilibrium level of income is determined when total leakages are equal to total injections.

CIRCULAR FLOWS OF INCOME AND EXPENDITURE WITH GOVERNMENT : A THREE-SECTOR MODEL:

Q.3 Explain circular flows of income and expenditure in a three-sector model.

Ans: The three-sector model is formed by adding the government sector to the two-sector model

A three-sector model includes (a) Households, (b) Firms, and (c) Government. It depicts (shows) a more realistic economy. Government plays an important role in the economy. Government makes many fiscal operations. In this simple analysis, we consider only three fiscal variables of government. These are (i) Taxes, (ii) Government Expenditure, and (iii) Transfer Payments.

(i) TAXES: Taxes are withdrawals from the flows. Because they reduce private disposable income, consumption expenditure, and savings.

(ii) GOVERNMENT EXPENDITURE: Government expenditure is an injection to the circular flows. Because it adds to the aggregate demand. Here, the government purchases factor services from the households and goods and services from the firms.

(iii) TRANSFER PAYMENTS: The transfer payments by the government (e.g. old-age pension, unemployment, allowances, subsidies, etc.,) are injections to the circular flows. They add to the income of households who raise demand for consumer goods.

This three-sector model is shown in the following figure:

Income Flows to Government (Withdrawals): Households pay some part of their income to the government in the form of direct taxes.

Similarly, firms also pay corporate income tax to the government, firms also pass on to the government indirect taxes which are collected from households. The government taxes reduce - disposable income and consumption of households, - sales and income of firms, - production and investment in the economy, and - the size of circular flows. Thus, with the introduction of government and collection of taxes by it, the magnitude of flows between households and firms is reduced. Because part of their income flows to the government sector. The situation is damaged by the government. Now, the government itself corrects this situation through its spending and transfer payments.

Expenditure and Transfer Payments from Government :

(Injections): Government spends a part of its tax revenue on wages and salaries paid to the households. It also makes transfer payments like old-age pension and unemployment allowances to households. Likewise, the government spends a part of its tax revenue on the purchase of goods and services from the firm. It also pays subsidies to firms.

Thus, the money that flows from households and firms to the government in the form of taxes flows back to these sectors in the form of government expenditure and transfer payments.

Tax Revenue (T) and Government Expenditure (G):

Therefore, T is withdrawal and G is injection. The net effect of T and G on the size of flows depends on whether T and G are equal or not. The budgetary policy of the government determines whether tax revenue and government expenditure are equal or not.

è If the government adopts a balanced budget policy, then G = T.

è If the government adopts a deficit budget policy, then G > T.

è If the government adopts a surplus budget policy, then G < T. The balanced and deficit budget policies indicate injections into the economy. So, they expand circular flows. On the other hand, a surplus budget policy indicates withdrawal from the economy. So it reduces circular flows.

Equilibrium Condition:

The total expenditure (E), in the economy, is the sum of consumption expenditure (C),

Investment expenditure (I), government expenditure (G). Symbolically, E = C + I + G ……… (i) The total income (Y) received is allocated to the consumption (C), Savings (S), and Taxes (T). Symbolically, Y = C + S + T …. (ii) Total expenditure is equal to total income (E = Y) Therefore, form (i) and (ii), we have, C + I + G = C + S + T …. (iii) Since C occurs on both sides, it will be cancelled out. Now we have I + G = S + T …(iv) Here, injections such as I and G are equal to withdrawal such as S and T. By re-arranging equation …..(iv) G – T = S – I …….(v) OR (I – S) + (G –T) = 0

CIRCULAR FLOWS OF INCOME AND EXPENDITURE IN A TWO SECTOR MODEL

Q.2 Explain circular flows of income and expenditure in a two-sector model.

Ans: The two-sector model includes only household sector and business sector (firms). It is a private closed economy. There is no government and no foreign trade. It is a simple and hypothetical model.

A two sector model is obviously an unrealistic model. However, it is a convenient starting point to analyze the circular flows.

The basic features and functions of the households and firms are as under :

 Households :

a) The households are the owners of all factors of production.

b) Their total income consists of rent, wages, interest and profit.

c) They are consumers of all the consumer’s goods and services.

d) They save a part of their income and supply finance to the firms through capital market.

 The Business Firms :

a) Firms own no resources of their own.

b) They hire and use the factors of production owned by household.

c) They produce and sell goods and services to the households.

d) They do not save (i.e. there is no corporate saving).

The circular flows of income and expenditure in a Two-Sector Economy is explained in following figure :

 The upper half of figure is related to Factor Market. In factor market,

-- Households provide factors of production (FOP) like land, labour, capital and entrepreneurship to the firms. This is Real Flow.

-- Households get factor incomes like rent, wages, interest and profit from the firms (as firms make factor payments to the households). This is Money Flow.

Factor services (real flow) and factor payments (money flow) are in opposite directions.

 The lower half of figure is related to Commodity Market. In commodity market,

-- Firms sell goods and services to the households. This is Real Flow.

-- Firms get payment for goods and services from households (as households make consumption expenditure on goods and services produced by firms). This is Money Flow.

Again we find that real flow and money flow are in opposite directions. Important Identities : The values of flows are equal.

For example ….

(a) Factor incomes are equal to factor payments i.e. Y  FP  w + r + i + p

(b) Household expenditure are equal to value of output i.e. w + r + i + p 

Thus, Y  FP Where, FP  w + r + i + p Y = household income, w + r + i + p  V FP = factor payments, V  Y w = wages, r = rent, i = interest, p = profit V = value of output

In short, Household Income  Factor Payments  The Money Value of output i.e. Y  FP 

The Two-Sector Model with Saving: To explain the role of saving, we assume that all savings are made by only households. Now financial sector is introduced in two-sector model. Here, financial sector includes only banks and financial intermediaries (FIs) like insurance companies, industrial finance corporations and so on. They accept deposits from the households and invest it in the business sector in the form of loans and advances. Now two-sector model with financial sector is shown in following figure :

Now, income of households (Y) is divided into two parts :

(i) Consumption expenditure (C) and (ii) Savings (S).

Both reach to the firms. C reaches directly and S reaches indirectly. Circular Flows in Two – Sector Model with the Financial Sector Equilibrium Condition :  The total expenditure (E) is sum total of consumption expenditure (C) and investment expenditure (I). Symbolically, E = C + I ……(i) 

The total income received (Y) is allocated between consumption (C) and saving (S). Symbolically, Y = C + S …. (ii)  Total expenditure is equal to total income i.e. E = Y or C + I = C + S ….(iii) By cancelling C, we have I = S …. (iv) It means injection (I) is equal to withdrawal (S)

Q.6 Explain the terms withdrawals and injections. OR “The magnitude of withdrawals and injections will expand or contract size of circular flows”. Examine.

REAL FLOW AND MONEY FLOW :

Q.5 Write a short note on real flow and money flow.

CIRCULAR FLOWS OF INCOME AND EXPENDITURE WITH FOREIGN SECTOR: A FOUR-SECTOR MODEL :

Q.4 Explain circular flows of income and expenditure in a four-sector model.

Exports (X) [ Injection ]:

IMPORT (M) [WITHDRAWAL]:

EXPORT OF MANPOWER [INJECTION]:

Effect of Foreign Trade :

The Equilibrium Condition :

CIRCULAR FLOWS OF INCOME AND EXPENDITURE WITH GOVERNMENT : A THREE-SECTOR MODEL:

Q.3 Explain circular flows of income and expenditure in a three-sector model.

Expenditure and Transfer Payments from Government :

Tax Revenue (T) and Government Expenditure (G):

Equilibrium Condition:

CIRCULAR FLOWS OF INCOME AND EXPENDITURE IN A TWO SECTOR MODEL

Q.2 Explain circular flows of income and expenditure in a two-sector model.

CIRCULAR FLOWS OF INCOME AND EXPENDITURE MEANING OF CIRCULAR FLOWS OF INCOME AND EXPENDITURE

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