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 These are in the form of investment, government spending and exports, savings withdrawn and used to finance investment, either directly through the purchase of capital goods or indirectly via financial institutions such as banks.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

What is the difference between economic growth and economic development? Growth is only individual dimension of development. Economic development is a complicated multi-dimensio

Two people are engaged in a joint project. If each person i puts in the effort x i , the outcome of the project is worth f ( x 1, x 2). Each person's effort level x i is a

Q. Relation between nominal and real interest rate? Relation between nominal interest rate, real interest rate and inflation  If we signify the nominal interest rate by R

A farmer grows a bushel of wheat & sells it to a miller for Rs. 1.00. The miller turns the wheat into flour & then sells the flour to a baker for RS. 3.00. The baker uses the f

What are long run and short run? Long run: It is the time period wherein all inputs cannot be fixed. Short run: It is the time period within which at least one in

ABC Sports, a store that sells various types of sports clothing and other sports items, is planning to introduce a new design of Arizona Diamondbacks' baseball caps. A consultant h

Q. Construction of real gross domestic product ? To be able to make reasonable comparisons of GDP over time, we should adjust for inflation. For instance, if prices are doubled

A scientist has been studying the organisms colonising the pilings underneath a wharf in Sydney Harbour. He postulates two factors might make these communities of sponges, worms, a

Major fiscal objective of Chancellor George Osborne The major fiscal objective of Chancellor George Osborne when coming to office in May 2010 was to remove the UK's structural