Circular Flow Of Income And Expenditure In 3 Sector Economy Elementary Theory of Income Determination – Cash Flow of Income

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Elementary Theory of Income Determination – Cash Flow of Income

The total income of a country is a reflection of real capital investments in that country. The volume of investments is primarily determined by certain factors. These factors include the expectations of entrepreneurs, the interest rate, savings, the marginal efficiency of capital, and consumption.

Income cash flow

The circular flow of income refers to the flow of payments and receipts for factor services and for currently produced output that takes place between domestic firms and households. In other words, it describes the flow of payments from firms to households in exchange for labor and other production services, and the reverse flow of payments from households to firms in exchange for goods and services.

Some of the basic factors that affect circulating current are:

1. Savings: This represents the portion of income that is not consumed immediately. They tend to reduce the expenditure of households and companies.

2. Input: The input of funds into the circle is an increase in the incomes of households and companies in addition to their normal processes of selling production resources and manufactured goods.

3. Taxes: Taxes usually reduce the volume of funds in circulation by reducing expenditure by businesses and households.

4. Withdrawal: Withdrawal tends to reduce the amount of funds in the circular income stream.

5. Aids and grants: Aids and grants from government or other sources increase the volume of funds in the circular flow of income.

6. Imports and Exports: While imports involve expenditure on goods and services produced abroad that lead to withdrawals from the circular flow of income, exports provide inputs that lead to injections into the circular flow of income.

7. Investments: Investments generate additional income that leads to an injection into the circular flow of income.

For a more comprehensive explanation, we can use a two-sector economy that includes households and businesses. Households supply production factors (inputs) to companies that need them for production purposes. In return, they receive wages, interest, rent, and profit, which represents their income. Household members use their income to purchase goods and services produced by businesses. This pattern of consumer spending by households represents income for businesses. This process leads to the creation of an income stream. Businesses again use the income to purchase productive services from households. So the income continues to flow in a circular fashion, forming a circular stream of income. While income flows in one direction, the goods and services produced by the firm and the productive services of households flow in the other direction.

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