The circular flow of income in an open economy, Macroeconomics

 

The circular flow of income in an open economy 

An open economy is one in which international trade exists. Assume also that there is government spending and taxation.

Thus households need not consume all of their income. Some may be saved (S), spent on imports (M), or taxed (T). So the savings (S) and imports (M) and taxes imposed (T) are known as "withdrawals" (W) or "leakages" from the actual flow. An increase in withdrawals (W) will reduce the level of output and income (Y).

However, Y will be added to investment (I), government spending (G) and money spent by foreigners on exports (X). These are known as "injections" (J).In an open economy the size of Y is determined by the size of AD, which is determined by C + I + G + X. 

 

 

1979_The circular flow of income in an open economy.png

 

 

 

 

 

Over a period of time there are withdrawals (W) from the income flow. If individuals save, then the income is taken out of the circular flow. If an economy's income is Rs.1,000 and it saves Rs.200, then only Rs.800 is passed on as expenditure. Other withdrawals are taxes and imports. The latter represent a loss of income from the domestic economy to some overseas economy.

Alongside withdrawals there are also injections (J) into the flow of income. These are in the form of investment, government spending and exports, savings withdrawn and used to finance investment, either directly through the purchase of capital goods or indirectly via financial institutions such as banks. Thus, the original withdrawal or savings ends up as an injection elsewhere in the system. Taxes end up as government spending on goods and services. Exports are financed from spending made by other countries. This spending enters into the circular flow as an injection of income.

In this economy

                 Y = AD

Therefore, Y = C + I + G + X

              Y= C + J

Where J equals injections i.e. I, G and X.

For equilibrium we require all withdrawals to equal all injections i.e. W = J. If injections are greater than withdrawals then the level of national income (i.e. total incomes) will rise, and vice versa. 

 

Posted Date: 9/12/2012 12:49:11 AM | Location : United States







Related Discussions:- The circular flow of income in an open economy, Assignment Help, Ask Question on The circular flow of income in an open economy, Get Answer, Expert's Help, The circular flow of income in an open economy Discussions

Write discussion on The circular flow of income in an open economy
Your posts are moderated
Related Questions

bank A has a leverage ratio of 10 while bank B has a leverage ratio of 20 similar losses on bank loans at the two banks cause the value of their assets to fall by 7 percent. Which

Will the Euro survives? 1. Why are Greece, Ireland, Italy, Portugal, and Spain sometimes referred to as the euros zones "peripheral countries"? 2. Why did the European commis

Money is anything which is acceptable in settlement of a debt. But, paradoxically, the main asset used to settle debts in modern economies is other debts. After all, bank deposits

What causes a demand curve to shift? a. Changes into the Prices of Related Goods Substitutes Complements b. Changes into Income Normal Goods Inferio

Foreign Direct Investment and Development: In neo-classical economic theory, FDI involves  the movement of capital from capital abundant  to capital scarce host countries. Mun

Assume a 5 year equal payment amortization schedule with an annual interest rate of 12% and annual payments. If the beginning is 8,000 then the first interest payment will be how l

How would I solve and graph this problem C=$1 (trillion)+.80Yd

Assume two individuals, A and B, are considering marriage, and each face the same amount of hours a week to be split between market-labor and home-labor.  Assume that A can make $2

Question 1: (a) Outline the three main methods of recruitment. (b) Discuss the advantages & disadvantages of any one method mentioned above.