MBA-I_SEM-II

Reiterating the Goals of Macro Economics Full employment Price Stability Economic Growth External Balance

There are mainly two types of flows in any economy: Real flow & money flow Real flows include the flows of the factors of production and the goods and services between different sectors. Money flows include the monetary flows between different sectors. Two sector model: Assumptions: i. HH spends all the income on the products of the firms (no savings by the HH); ii. Firms produce the goods demanded by the HHs and distributes all its earnings and not retained any of its earnings.

Two sector economy: House holds and the firms Top half
of of inner line: total income from the producti on of goods and services = Wages+ rent+int erest+p rofit. Bottom half of the inner and outer line:Tota l

Factor services Factor incomes

Househo lds

Firms

Expenditure on goods and services Flow of goods and services

The Inner line: Money flow: The flow of factor incomes (wages, rent, interest and profit from firms to the households The flow of expenditure on goods and services from the households to the firms The outer line : real flow of factor services: Flow of factor services (labour, land, capital & entrepreneourship) from HH to firms

Withdrawals and Injections

Withdrawal(leakage) is generated in the production of national output, hence it is not a part of national output. Injection is the amount of money which is spent by different sectors in the economy which is in addition to the incomes generated in the circular flow of income. This is included in the national income.

Factor incomes Injections (+) Househol ds Withdrawals (-) Firms

Injections (+): Withdrawals Investment, Govt (-) Expenditure on goods exp and exports Savings: and services S=Y-C

 Summing up in an economy: National Income = national expenditure In Two sector economy the inner line reflects the money flow and the outer line reflects the real flow Withdrawal is income which is generated in the production of national output and is not part of circular flow of income Injection is the amount of money spent by different sectors in the economy and which is an addition to their incomes generated in the circular flow of income In two sector model Withdrawals are: savings and Injections are investments.

Three sector economy: In addition to the HH and firms, one more sector is added i.e, Government sector. Govt plays an important role in the many economic activities. For simplicity let us assume govt raises revenue in the form of taxes from the households and from the firms/corporate sector either in the form of direct taxes or indirect taxes. If T is Total tax then T=TH + TF (i) Govt spends money on many heads i.e. administration, justice, defense, social welfare, subsidies and so on. G = GH+GF+GS+GT (ii) G= total govt exp GH = Payments made to the households sector for the services rendered by them GF = Payments made to the firms for the goods and services bought from them GS = Govt subsidies to the firms GT = Govt payments for social security and welfare In three sector model:

part of the flows from the households and from the firms goes to govt in the form of taxes Part of the tax revenue is spent by the govt as govt exp to provide services and transfer payments to the households Part of the tax revenue is spent by the govt on purchase of goods and subsidies to the firms
In three sector model withdrawals are: savings and taxes while injections are investments and govt expenditures

Three sector economy: Households, firms and Government

Governme nt Factor services Factor incomes

T a x e s

T a x e s

Househol Capital Capital Firms ds market market savings invest ment Expenditure on goods and service Flow of goods and services

 Four sectors: HH, Firm, Govt and Foreign sector In the foreign sector only two dimensions are considered: Imports and exports:
When a country imports the goods and services, the expenditure incurred by the residents of the domestic country leads to an increase in the income of the factors of production of the country which is exporting the goods and services. Imports lead to an outflow of income decrease in circular flow When the country exports the goods and services, the expenditure incurred by the residents of the foreign country leads to an increase in the income of the factors of production in the domestic country. Exports leads to inflow of income- increase in circular flow

If exports are less than imports X< M, foreign trade deficit, Un favourable balance of trade Exports are greater than imports X>M, foreign trade surplus - favourable balance of trade.

Four sector economy: Households, firms, Govt & Foreign sector

Governme nt Factor services Factor incomes Govt exp on goods and subsidies

T a x e s Househol ds

T a x e s Firms

Capital market saving invest s ment

Payment for exports Payment for imports

Expenditure on goods and service Flow of goods and services

Foreign sector