Prepared by:N. JYOTI

THREE SECTOR MODEL

CIRCULAR FLOW OF INCOME & EXPENDITURE

WITH GOVERNMENT

The Circular-Flow Diagram

The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle

Circular-Flow of Economic Activities

•A household is a person or a group of people that share their income.

•A firm is an organization that produces goods and services for sale.

•Firms sell goods and services that they produce to households in markets for goods and services.

•Firms buy the resources they need to produce—factors of production—in factor markets.

The Government Sector

• Government taxation (T) reduces households’ disposable income and business funds

• Government spending (G) includes expenditure on collective goods and services and goods and services provided by the business sector, plus transfer payments

Three Sector Model

Leakages and Injections

• Leakages in the circular flow: Flows out of circular flow when resource income is received and not spend directly on purchases from domestic firms – Savings(S)– Taxes(T)• Injections in the circular flow: Added

spending in circular flow that does not come out of current resource income

– Investment(I)– Government spending(G)

Savings and Investment

If planned (I+G) = planned (S+T)so that injections = leakages

and total spending = total income

and demand = supply

then we have a stable we have a stable economyeconomy

Contracting Economy

If leakages are HigherHigher than injections (Planned S+T > Planned

I+G), economy contracts resulting in– inventory accumulation– too little spending– drop in prices

Expanding Economy

If injections are HigherHigher than leakages (Planned I+G > Planned S+T), economy expands resulting in– more goods and services produced– higher prices

Government and the Circular Flow

• Balanced budget:– amount spent by government (G)=

amount collected in taxes(T)• Surplus budget

– amount spent by government (G)< amount collected in taxes(T)

• Deficit budget– amount spent by government (G)>

amount collected in taxes (T)

AnyQueries