Model of economic circulation: from simple to complex, types, models, scope

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:55

The economic model of the circulation of income, resources and products is a diagram that reflects the key areas of material and financial flows in the economy. It shows the relationship between markets and economic agents.

Key elements

Households (families) and enterprises can act as economic agents in the model of economic circulation. The former possess all the production resources of society, the latter use them in the production process. Resources are divided into 4 groups: capital, labor, land, entrepreneurial ability. Consider briefly their characteristics.

Description of factors of production

Labor is the physical or intellectual activity of a person,during production.

Capital is money created by people. This resource includes not only finances, but also machines, construction objects, buildings, structures, equipment, raw materials, transport, semi-finished products, etc.

Natural resources include not only land, but also all natural objects in the occurrence (creation) of which a person did not participate. We are talking, in particular, about subsoil, forests, etc.

Entrepreneurial ability is a specific production factor. The peculiarity of entrepreneurial activity is that the economic entity assumes a certain risk of loss. The fact is that there is no guarantee of income from certain operations.

When the owners of these factors unite, an enterprise arises.

Types of income

The four production factors described above also correspond to 4 types of remuneration:

1. Work is wages.
2. Capital - interest.
3. Land is rent.
4. Entrepreneurship is profit.

The most important circumstance follows from the latter. In economic theory, normal profit is not seen as the difference between revenue and expenses, but as a necessary reward for entrepreneurial activity.

Circulation model of economic benefits

Households sell their inputs to various businesses through markets. Companies, in turn, turn the acquired funds into finished goods. Their businesses are sold to households at commoditymarkets. Thus, the material flow moves in the model of economic circulation.

In a market economy, however, there are always 2 streams. Money moves towards goods. In the circular economy model, businesses pay money to households. The incoming amounts are incomes expressed in the form of wages, rents, interest, profits. Accordingly, households spend the money received on the purchase of necessary services and goods.

Specific features of a simple economic circulation model

Producers of consumer goods are enterprises (firms). However, they need resources to produce products.

Households in the economic circulation model act as business units consisting of one (or more) persons supplying enterprises with the means of production and using the money received for them to purchase services and goods that satisfy the spiritual and material needs of a person. These subjects indirectly or directly possess all resources. However, they also need commodities because they are consumers, not producers.

In the economic model of the circulation of income, the most important link is the resource market. Here, households offer the means of production to enterprises that demand them. When supply and demand interact, the cost of resources is formed. The means of production thus go to enterprises, and money flows to households. Firms paythe cost of resources, in the form of production costs.

Besides, there is a commodity market in the economic circulation model. Here, businesses offer their products to households in demand. Accordingly, the interaction of supply and demand in the market forms the cost of consumer products. Items are thus transferred from firms to households. The latter pay the cost of goods in the form of consumer spending, while enterprises receive income from the sale of their products.

This scheme is a model of economic circulation, since there is a circular movement of goods - products and resources. At the same time, it is accompanied by a counter cash flow, in which the incomes and expenses of households and enterprises move. It must be said that the uninterrupted functioning of the economic circulation model is ensured due to the equality of cash income and expenditure flows.

Participation of financial institutions

The above model of economic circulation greatly simplifies the real state of affairs, since it is assumed that all household income received is spent on current consumption. In reality, people tend to save some of their money.

There are many ways to save income. In a market economy, the most common situation is when shares of enterprises are purchased with the funds received, the amounts are placed on bank accounts, which, in turn, then provideloans to businesses. Stock exchanges and banks are financial market institutions. Through these platforms, household savings enter enterprises in the form of investments or capital investments. Companies use money to increase their capital: to purchase equipment, machines, machines, etc. In any scheme, there are counter flows. In the situation considered, households saving money in banks receive interest transferred by enterprises for using money.

Accordingly, it is possible to determine which model is not a model of economic circulation. It cannot be recognized as a scheme in which one of the two flows is missing.

Nuances

The most important conclusion follows from the above information. Investment activity cannot be carried out without household savings. Funds allocated for the purchase of new capital are a prerequisite for long-term economic growth. Accordingly, the higher the volume of savings in household income, the higher the rate of economic growth (ceteris paribus). China is proof of this. In this country the share of savings is very high. This volume also leads to large investments. Accordingly, they lead to intensive economic growth.

Meanwhile, it happens that the share of household savings is relatively small, while investment activity is carried out very intensively. This is possible if the state attracts external savings.

Participationstates

In the full model of the economic cycle, the most important place is occupied by state power. Her tasks include:

1. Tax collection.
2. Redistributing income through transfer payments.
3. Paying salaries to civil servants.
4. Acquisition in product and resource markets.
5. Production of public goods, services, goods.

Complication of the scheme

The government-invested model reflects the process by which production expands. In this case, households do not spend all their income on consumption, but save a part of it. The redistribution of these funds that are not involved in the acquisition of goods, their transformation into investments takes place with the participation of banks, which act as intermediaries.

After collecting taxes, the state purchases the resources and goods necessary for its activities in the respective markets. They provide services to both households and businesses. Examples include national defense, standards development, judiciary, etc.

Budget deficit

It occurs when government spending exceeds its revenues. Since taxes and other revenues are approved, the deficit can be covered by borrowing. The main sources of funds in this case will be loans from the Central Bank and loans in the financial markets, the latter concentrate the savings of the population of thiscountries and foreign citizens.

Loans at the Central Bank imply an additional issue (issue) of money. This, in turn, can lead to inflation. If borrowing is carried out in the financial market, inflation may not occur. In particular, it can be avoided if the savings of the population are directed to the purchase of government bonds, and the owner of the money changes for a while before maturity. In this regard, this source of financing the deficit is called non-inflationary.

Important moment

A non-inflationary approach entails a negative consequence - the so-called crowding out effect. The bottom line is that the state, in an attempt to attract financial resources, begins to raise the rate on loans. Accordingly, many enterprises are unable to take money under the new conditions. They are left without investments, they cannot buy equipment and other production means. Thus, there is a crowding out of private investment by government spending.

The whole picture can be described as follows. Household savings flows are channeled into the investment field of enterprises. Suddenly, a dam and a channel appear in their path, where the main part of the flow goes. There is very little money left for investment. In the long term, all this will lead to a slowdown in economic growth. The problem can be solved by attracting capital from abroad.

Key signs of participants in the circuit

The model of the counter movement of material and monetary income reflects a complex interweaving of interrelated activities: management and production. It should be noted that both households and businesses operate in two main markets, but on opposite sides in each case. In the resource market, firms are buyers. That is, they act on the demand side. Households, in turn, are the owners of resources. They work on the supply side. In the commodity market, their positions are changing. Households now act as consumers, i.e. buyers, and businesses as sellers. At the same time, each entity both sells and buys.

All transactions made by households and businesses have the sign of rarity. The fact is that individuals have at their disposal only a limited amount of resources to supply firms. Accordingly, their income is also limited. This means that the profit of each consumer is within certain limits. This limited financial resources does not allow to buy all the services and goods that the consumer would like to have. It follows that the production of finished goods is also rare, because resources are limited.

Conclusion

Economic circulation, thus, is the movement of income and expenses, resources, money, products in the field of economic activity. In his scheme, the monetary and real sectors are distinguished.

The movement of finance and products covers 4 key areas: production, consumption, exchange and distribution. The first involves the transformation and adaptation of materials to meet human needs.needs. Exchange is the movement of goods and services from one market participant to another. The distribution involves the identification of quantitative parameters of resources and indicators of economic activity. Consumption is considered the final act of the economic process. It is the ultimate goal of production. Households demand consumer products, while businesses demand investment products.

Investment resources are used to expand and upgrade production. They are directed to the composition of financial assets, replenish stocks, increase fixed capital.

The end result of the economic process is the emergence of a real flow of resources counterclockwise and cash flow with consumer spending - clockwise. They are simultaneous, endlessly repeating.