Circular Flow Model - Economics Essay Example

Circular flow model definition

The circular flow model presents a simplified picture of how money flows through a market economy, A. There are three important equations that come out of the circular flow model. They come from looking at flows into and out of households, firms and if you choose to think of it this way, financial markets.

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I.What equation is related to flows into and out of households?

Y=C

Explain which components flows in and which ones flows out?

Components flowing in include Goods and Services

Components flowing out include Factors of Production such as labor

II.What equation is related to flows into and out of firms?

Y=E=O

Explain which components flows in and which ones flows out?

Components flowing in include Resources

Components flowing out include Output

Circular flow model economics

III.What equation is related to flows into and out of financial intermediaries?

S+T+M=I+G+X

Explain which components flow in and which flow out.

Components that flow in include Investments, Government Spending and Exports

Components that flow out include Savings, Taxation and Imports

Consider an economy in which I= 800, S= 700, T= 500, G= 600 and with M=X.

Using the third equation you found in part A, show that the financial market is not in equilibrium

S+T+M=I+G+X

700+500=800+600

1200<1400

For an economy to be in a state of equilibrium S+T+M must be equal to I+G+X but in this economy S+T+M are less than I+G+X.