Circular Flow of Payments and National Income

To havea glimpse in the working of the economy as a wholemay beof use to a student of economics.

In every economy there are lots of households tosupply labour and capital to firms that use them to produce goods and services. Firms provide incomes for households, who in turn use this money to purchase the goods and services produced by firms. This process is called the circular flow of payments.

The gross domestic product ( GDP ) is the total money value of all final goodsproduced in the domestic economy over a one-year period. The GDP can be measured in three ways: (a) the sum of the value added in the production within a year, (b) the sum of incomes received from producing the year’s output, (c) the sum to spend on the year’s domestic output of goods and services.

The total money value of all final goods and services in an economy over a one-year period that is the GDP, plus property income from abroad (interest, rent, dividends and profits) make the gross national product (GNP). The GNP is an important measure of a country’s economic well-being, while the GNP per head provides a measure of the average standard of living of the country’s people. However, this is only an average measure of what people get. The goods and services available to particular individuals depend on the income distribution within the economy.

We now recognize that assets wear out in the production process either physically or become obsolete. This process is known as depreciation.

There has to be part of the economy’s gross output to replace existing capital, and this part of gross output is not available for consumption, investment, government spending, or exports so we subtract depreciation from the GNP to arrive a national income.

National income measures the amount of money the economy has available for spending on goods and services after setting aside enough money to replace resources used up in the production process.

Since output is determined by demand, the aggregate demand or spending on goods and services after setting aside enough money to replace resources used up in the production process.

Since output is determined by demand, the aggregate demand or spending plans of households and firms determine the level of the output produced, which in turn makes up the income available to households. Aggregate demand is the amount to be spent by firms and households on goods and services.

Governments also step in the circular flow of income and payments. They buy a considerable part of the total output of goods and services in an economy adding their demand to the demand of the private sector. Since government spending is a large component of aggregate demand, and since taxes affect the amount households and companies have for spending, government spending and taxation decisions, which are referred to as fiscal policy, have major effects on aggregate demand and output.

2. Insert into the texts (a) and (b) conjunctions and prepositions, where it is necessary:

(in, to, of, while, by, who, which, on, since, through, where, however, for)

a) Household is a group of people...make economic decisions together. In economic theory households have two roles: they enter the market as buyers or consumer... goods and services produced...firms and they provide... factor inputs... firms... order to produce those goods and services. The term "household" is used... national income analysis,...... supply and demand analysis it is replaced… the term "consumer".

b) Black economy is nonmarket economic activity... is not included... the national income accounts, either because such activity does not pass… the market or because it is illegal. Illegal economic activity may exist in the usual price system...is determined... demand and supply. Examples may be the purchase and sale of illegal drugs... the street, or alcohol... the US prohibition era... the 1920s.

…, some nonmarket activity is carried out... non-profit-making purposes. For example, a housewife provides services... her family. Other nonmarket activity is done... a barter basis, for example, …..a mechanic serves a motor car of an electrician….. in return helps the mechanic install light fittings ….the house. …..there has been no money paid, the activity does not add …….the GDP and so does not exist for statistics.

3. Answer the questions to the text Circular flow of Payments and National Income.