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Explain in detail the complex circular flow of income model

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Introduction

Explain in detail the complex circular flow of income model (AS Economics) The circular flow of income model shows linkages between the main sectors in our economy. The basic circular flow of income model is made of of two key sectors, households and firms. Households provide 'factor services' to firms, and firms provide 'factor income' to households. Factor services include labour, enterprise, land and capital. In return for these factor services, households receive factor income, which therefore are wages (for labour), profits (for enterprise), rent (for land) and interest (for capital). When households receive this income as a reward for their factor services, they use it to buy the goods and services from the firms. ...read more.

Middle

This constitutes a leakage. Government expenditure to households includes welfare state payments such as benefits, state pension and improving or renovating houses/areas. Firms also benefit from government expenditure, for example through their spending on helping new enterprises start up and survive. Health, transport and education are the other main categories for government expenditure. Finally, for the complex circular flow of income model to be complete, the finance sector and the foreign trade must be added, alongside firms, households and the government. Previously, it was assumed that households expenditure was to the firms only. However, households save money as well as spend it on imported goods. As households save some of their income by depositing it in banks for example, leakage from the circular flow occurs as a result. ...read more.

Conclusion

The money from exports being sold overseas will be injected into the circular flow, whilst spending by UK customers and UK based business on imported goods represents a leakage from the economy. This is because the money from the UK households/firms to purchase the goods from abroad flows out of our economy and into the foreign economy and vice versa. Looking at this model as a whole, it's clear to see that if the withdrawals (imports, savings, tax) are greater than the injections (exports, capital investment, govt spending) the over all income in the circular flow will decrease. Similarly, if the injections are greater than the leakages, the over all income in the circular flow (national income) will increase. This could have an effect on some of the governments main economic objectives by reducing unemployment, helping economic growth occur and rise inflation. ...read more.

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