Civil Engineering Reference
In-Depth Information
by ignoring the government sector, the financial sector and the overseas sector - that
is, the
circular flow model
represents a simplified, scaled-down economy in which
relationships are assumed to exist only between households and businesses.
To make the model effective, it is assumed that households sell factors of
production to businesses and in return receive income in the form of wages, interest,
rents and profits. This is shown in the bottom loop in
Figure 1.4.
The businesses sell
finished goods and services to households in exchange for household expenditure.
This is shown in the top loop in
Figure 1.4.
These assumptions are reasonably
realistic. Businesses will only make what they can sell. Production will necessitate
buying in land, labour, capital and enterprise, and the monies paid for these factors
of production will generate respective income payments.
Already, without building in any of the complications of the real world, we
begin to sense several insights or starting points. Clearly there is a close relationship
between the income of a nation, its output and the level of expenditure, and we
shall investigate this further in
Chapter 13
. Also, we can see how money enables
households to 'vote' for the goods and services desired, and this will be developed
further in
Chapters 2
to
5.
The perceptive reader will note that the model fails
to include any reference to the environment and, as we explained above, this
represents the contents of
Part B.
The model also explicitly excludes reference to the
role of governments, overseas economies and financial institutions and these aspects
are included in
Part C.
Again we can see how the model enables us to progress into
the subject.
Figure 1.4
The circular flow model: a two sector economy
In this simplified model there are only households and businesses. Goods and services
flow in one direction in return for money. This exchange can be thought of as a
circular flow.
ex
+
Businesses
Households
pi
nt
