The spherical Flow of Economic Activity and Understanding Macroeconomics

The spherical Flow of Economic Activity:

When economists mention the "circular flow" of economic activity, they have a specific picture in mind. They see prototypes of income, spending, and production like liquid flowing via several sets of pipes. In this extensive metaphor, categories of agents in the economy, all businesses, or government, or households, are the pools into and out of which fluid of purchasing power (it implies that money) flows.

So economists think of economic activity, the pattern of manufacture and expenditure in the economy as a spherical flow of buying power through the economy. This spherical flow metaphor allows them with assurance to predict that changes in one part of the economy would affect the whole, and in what ways. It allows them to make simpler economic behaviour, to understand the whole set of decisions taken by several agents in several portions of the economy by thinking of a small number of distinctive decisions taken by abstract representative agents.

Revenue, production, and expenses can be measured at 3 different points in the spherical flow. Economists calculate GDP at the point, where customers, exporters, the government, and industries which are making investments buy merchandise and services from businesses. This measurement is the real GDP, or total output. It is total economy-wide manufacturing of merchandise and services. It is "expenditure side" measure of circular flow.

measure the point of economic activity too at point in circular flow where businesses pay households for factors of manufacturing. Businesses need labour, assets, and natural resources, all factors of production owned indirectly or directly by households. When businesses purchase them, they make available households with incomes. This measurement is termed as total revenue or National income. It is "income side" measure of circular flow.

Third, economists measure the stage of economic activity at point where households decide how to use their income. How much do they save? How much do they give in taxes? How much do they expense on consumption goods? This measure of circular flow of economic action is the "uses of income" measure.

The measure used for the most part is often the expenditure side measure: the ‘Gross Domestic Product’ produced by industries and required by customers. It is approximated by counting up the 4 elements of expenditure (and sales): investment, government purchases, and consumption and net exports. If we evaluate the expenditure-side measure of GDP with income side or uses of ‘income side measure, ’  we would find that aside from differences created by different accounting principles they are equal (see Box below). They are identical because circular flow standard is designed into the “National Income and Product Accounts (NIPA).”  Every expense on a final merchandise or service is accounted for as payment to a business. Each dollar payment which flows into business is then accounted for like paid out to someone. It could be paid out as income, wages, the fringe benefits, interest, profits, rent, or like an expense on merchandise or services of another industry that then in its turn purchases factors of production.

What if you wish for withdraw your earnings from circular flow? Assume, for example, you basically take the dollar bills you get and use them to purchase something old and valuable from another household e.g. a bar of gold, say. And imagine you keep that bar of gold in your underground room. Doesn't that break circular flow? The answer is, it does not. You no longer have your income, but the household which you purchased the gold bar from, does. That household shall then either spend it on consumption merchandise, save it, or have it taxed away.

What if you made your mind up to hide the dollar bills themselves in your underground room? Doesn't that break circular flow? The answer is that it doesn’t. The “Bureau of Engraving and Printing” will notice that the total number of dollar bills circulating in the economy has dropped. It would print up more dollar bills, and hand them to the Treasury. The government will use these extra dollar bills, and so substitute the ones you have hidden. The net result would be the same like if you had saved that part of your income by loaning it out to government and had bought a Treasury bond. There are only 2 differences between buying a Treasury bond and your underground storage scheme. The first is, you have a stack of dollar bills in your underground instead of a piece of paper with the words "Treasury bond" written on it. The second is, the government does not pay interest on dollar bills stacked in your basement, but it does pay interest on its bonds. In circular flow figure, you have saved this portion of your earnings, and you have saved it in a comparatively pointless way by making the government an interest-free loan.

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