subject: Explain the circular flow of income in a four sector economy? [print this page] Explain the circular flow of income in a four sector economy?
CIRCULAR INCOME FLOW IN A FOUR SECTOR ECONOMY
*INTRODUCTION:
~ The four sector economy includes households, business firms, financial sector and the government sector.
~ The government sector is very important because it affects the working of the economy in a number of ways through public revenue, public expenditure and public borrowings.
*ASSUMPTIONS:
i) Firms retain some part of their profits i.e. they do not distribute the entire profit earned by them.
ii) These retained savings are used by the firms for future investment.
iii) Only tax revenue is considered for public revenue.
*ILLUSTRATION:
*EXPLANATION:
~ The above figure depicts the circular flow of income in a four sectored closed economy.
~ The four sectors comprise of households, business firms, financial sector and government sector.
~ The real flow of income takes place as the households supply factors of production (land, labour, capital and enterprise) to the firms and the firms provide the households with goods and services that are produced by using the above factors of production.
~ The money flow of income takes place as money flows firms to households in the form of rent, wages, interest and profits and from households to firms in the form of consumption expenditure.
~ However, households save a part of their income in the capital market which becomes the investment expenditure of the firms.
~ Also, the government sector constitutes a large share of income flow and this affects the working of the economy in the form of public revenue, public expenditure and public borrowing.
~ The income flow of the household reduces as it contributes towards the government revenue in the form of personal income tax and commodity taxes which is utilised by the government in the form of public expenditure on infrastructure, defence, education, transfer payments, etc.
~ Moreover, the government also undertakes public borrowing from the capital market and adds to the flow of money.
~ Similarly, the income flow of the business sector also reduces as it contributes towards public revenue in the form of various types of taxes. The government purchases various goods and services from the business sector and also provides various subsidies to the business sector. This also, adds to the circular flow of income. Thus the circular flow of income remains in equilibrium.
*CONCLUSION:
~ Thus the inclusion of the government sector affects the working of an economy to a large extent through public revenue, public expenditure and public borrowing.
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