Abstract
In most economies, the resources are scarce and limited which calls for proper planning and allocation of the limited resources. Economic operations of a particular region are represented in the circular flow of income, whereby various sectors of the economy are represented. In the flow, all the players have their specific roles to enhance the optimization of the resources available. As enterprises and firms are going global, there are benefits and costs associated with the move, which calls for planners and economists in the enterprises undertaking the move to analyze the world market consciously.
In this article, various economics aspects will be analyzed with circular flow of income in an economy taken into consideration. The paper will conduct a review on how the government and other players impact the economy. Also, the article will stipulate the role of international trade in enhancing the productivity and efficacy of an economy. In the last section of the paper, microeconomics and macroeconomics will be distinguished.
As businesses and production firms indulge in the manufacturing process, the managers should ensure that they have a combination or estimation that employs the available resources optimally. The estimate of the output to be expected can only be possible through the development of production possibility frontiers, which calls for managers and planners to develop certain models.
In the circular flow diagram, there is an interaction between various elements of an economy. The interacting aspects are the government, the firms in the economy, the households who form the consuming society, the global sector which is usually foreign and the financial sector, which is controlled by the central bank of that particular state. In a two sector economy, there are only the households and the production firms. The consumers provide labor to the enterprises, which enhances the manufacturing process. Through the provision of their services, the individuals can earn an income in the form of wages and salaries, which they use for their expenditures. Also, the consumers in an economy provide a market for the goods and services that firms produce.
On the other hand, when the government is introduced into the circular flow of income, it becomes a three sector economy. Here, the government plays the role of smoothening the trade and economic activities, and this is done through public spending and taxation. Government expenditure constitutes of an injection in the flow of income while taxes are a leakage from the circular flow. Through taxing households and firms, the government can raise revenue that it can use to invest in the economy through actions such as the development of the country’s infrastructure and the creation of public projects. Through such investments, the government creates jobs that provide the households and consumers in the economy with an income to save and consume. The roles that the government plays include: making transfer payments to households as retirement pensions and unemployment reliefs, provision of social services such as education, housing, health and recreation facilities to the individuals in the economy.
The firms and the government interact through taxation and other regulations that are stipulated by the rule of law. Businesses and enterprises in an economy need to be monitored by an autonomous body, which checks and ensures that the undertakings and operations of firms are legit and ethical. Through taxation, the government tracks the profits of enterprises, which ensures that those enterprises are not exploiting the consumers. The government lowers the cost of production through providing subsidies in the manufacturing process. When the cost of production is reduced, the price of the final product goes down which makes the output affordable to the consumers. Increased consumption results to increased revenue to the government since the products being consumed are taxed. Also, the government buys commodities and services it requires from the business sector and makes transfer payments to those business sectors; hence, encouraging such investors.
The financial sector in the circular flow of income has the role of providing financial services to the households, the government and the firms in the economy. The financial services that commercial banks offer enable consumers to manage their funds well through savings, since saving ensures that the households maintain their consumption level because the savings earn interest. The players in the circular flow of income can easily transact using their resources through the incorporation of the financial sector. Commercial operations of an economy are autonomously controlled by the central bank in that respective state. The central bank controls and monitors the value of the currency; hence, checking the inflation rate in the economy. Investments by the players in the economy are enhanced by the financial sector since the industry can either fund the investors via loans or provide a forum whereby the investors can invest and manage their finances accordingly.
Most economies are open in that they incorporate trading activities with other nations; hence, international trade is also integrated into the circular flow of income forming a four-sector economy. When an economy exports commodities, they constitute an inflow into the economy since the exports provide income to the domestic producers. On the other hand, imports are leakages from the circular flow because the importers tend to incur the expense of purchasing the product from a foreign country. Hence, households and other players in the economy can either earn income or incur expenses from the international trade.
Trading with foreign nations has various benefits which include:
• Provision of a variety of products since there are many producers are endowed with different raw material
• Specialization because countries embark on producing in fields that they have adequate resources, or there is the presence of a comparative advantage
• There is large scale production since there is a global market which reflects higher sales hence large profit margin
• Stabilization of prices since the world market uses a universal currency which is usually in dollars that are relatively stable
• Increased efficiency in the economy since there is an exchange of technical knowledge and labor and there is international competition which increases the productivity of local firms.
However, international trade has its shortcomings such as killing the local infant industries since they are unable to match up with the international competition. Also, some economies tend to use other lower income countries as dump sites; hence, exporting substandard goods to such states. When international trade is not checked, it can lead to a deficit in the balance of payment because countries, sometimes, tend to import more than they export.
Figure 1: A figure showing circular flow of income in a four-sector economy (Extracted online from tutor2U)
Production Possibility Model
Figure 2: A sample of production possibility frontier curve taking wheat and cotton into consideration (Extracted online from Tutor2U)
Production possibility model refers to a curve that represents possible output level of firms in an open economy. The curve shows two goods and the maximum output combination an economy can achieve after optimizing its resources in the production process. The resources in a firm can be used to produce various goods, but since they are scarce, a profit-maximizing choice or an optimum combination of resources must be made for efficiency in the firms. Hence, there is the incorporation of opportunity cost in the production process whereby increased production of a particular commodity must be followed by reduction of the production of other goods. Through the production possibility frontier, trade-offs in production can be made to fit the budget of the production firm.
The field of economics is divided into two major branches: microeconomics and macroeconomics. Microeconomics focuses on the demand and supply of single markets, the consumer theory and behavior, the labor market and market externalities such pollution by the firms. On the other hand, macroeconomics is concerned with economic aspects such as inflation control, globalization, Gross Domestic Product of various economies, government influence in trade and monetary and fiscal policies. In general, the difference between the two phenomena is that while microeconomics focuses on small segments of the economy, macroeconomics views the whole economy.
In conclusion, let’s review the report in a summary
• In any economy, various players involved include the government, the households, firms and business organizations and the financial sector
• All players in the economy have their specific roles
• The central bank of an economy values the currency and monitors inflation
• Globalization has advantages and shortcomings in local trade, with the benefits exceeding the costs; hence, globalization is recommendable
• Managers in firms need to estimate their outputs and make the best fitting combination of production through production possibility frontier
• The difference between macroeconomics and macroeconomics is that while micro deals with specific markets, macro focuses on the whole economy.
References
Understanding the Circular Flow of Income and Spending | Economics | tutor2u.(2016). Tutor2u.net. Retrieved 14 May 2016, from http://www.tutor2u.net/economics/reference/circular-flow-of-income-and-spending
