The circular flow of income and expenditure refers to the continuous production of products and services, income and expense in an economy. The different parts of expense and national income, for instance, investment, saving, exports, imports, government expenditure, taxation, etc. are displayed as currents and cross-currents in the circular flow of income.
Importance of the Circular Flow
The central concept of a circular flow is that it gives a clear picture of the economy. It also helps in understanding whether the economy is operating efficiently, or there are any obstacles in its smooth operation.
Therefore, the circular flow is significant for the functioning of the economy and helping the government in formulating various policy measures. Apart from the economy, the other important factors are.
- Effects of Leakages and Inflows – The leakages allow us to study the national economy and its impact. For instance, imports are leakages going out of the circular flow of income, as it is paid to a foreign nation. To prevent this leakage, the government should acquire suitable measures such as decrease imports and increase exports.
- The connection between Consumers and Producers – It builds a link between consumers and producers.
- Builds a Network of Markets – After creating a link between the consumer and producer and a network of markets for various products and services, problems relating to purchasing and sales are solved automatically.
- Basis of Flow of Funds Accounts – It helps in evaluating a country’s income in terms of the flow of funds accounts. These accounts are concerned with transactions of the economy that are fulfilled by money transfers.
- Importance of Monetary Policy – It brings equality between investment and saving in the economy indicates the importance of fiscal policy.
- The base of the Multiplier – In case, in a circular flow of income, if the leakage exceeds the injections, the total income becomes less than the total output.
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