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Circular Flow Of Income Essay

1686 words - 7 pages


Five-Sector Flow of Income Model

The five sector circular flow of income model describes the operation of an economy and the links between the major sectors in the economy. The circular flow of income model often features five sectors. A sector is a part of the economy where the participants are engaged in a similar type of economic activity. The five major sectors are:

Individuals (e.g Households)

Businesses (e.g Firms)

Financial Institutions (e.g Banks & Building Societies)


International Flows


Individuals supply factors of production such as labour and enterprise to businesses, who use these to produce goods and ...view middle of the document...

These institutions mobilise savings by receiving deposits from individuals and lending them out to businesses for investment purposes.

Savings represent a leakage from the circular flow, as money is taken out if the system and placed aside. This leakage results in a reduction in the size of the circular flow of income and thus the level of economic activity. In order to counteract the leakage of savings there is the injection of investment. Investment is defined as current expenditure that is made in order to attain benefits for the future (e.g the purchasing and use of capital goods). Savings are essential for investment to occur, as without savings there is no money left over for investment.


In Australia there are three levels of government - Commonwealth (federal), state and local. In terms of the circular flor model the government has two major roles - taxation and government expenditure. It taxes individuals and businesses and uses the revenue generated from this on government expenditure (usually collective wants such as roads and schools).

Taxation represents a leakage from the circular flow. Similar to saving, when individuals and businesses pay tax they have less money to spend on goods, services and resources. Government expenditure represents an injection into the circular flow as it provides income to government employees as well as transfer payments to pensioners and those who are unemployed.

In the September quarter of 2012, the government spent $67.256 billion dollars and in the December quarter the government spent $67.769 billion dollars representing a 0.7% increase in government expenditure. The circular flow model suggests that increased government spending should result in an increase in the level of economic growth. This holds true for the September to December quarters which showed an increase in GDP (or level of economic output) by 0.6%.

International Flows

This sector refers to all the transactions our economy has with the rest of the world. These include: imports (goods and services produced overseas and sold in Australia), exports (goods and services produced in Australia and sold overseas) and international money flows (financial...

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