Income Flows: Closed and Open Economy, Sectorization of an Economy

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The production units produce goods or service are generally sold for money. Sale of a good or service involve two way of flow. One flow is from the buyer and the other is from the seller. These flows are called the real flows and the money flows. The flow of good or service from its seller is a real flow while the flow of money from the buyer is a money flow.

  • The distinction between a closed economy and an open economy and

  • The division of an economy into different groups or sectors.

Closed Economy vs. Open Economy

  • Now a days every country has some economic relations with other countries. All the countries buy goods and services from each other. Borrowing and lending also takes place among different countries.

  • A country which has economic relations with the rest of the world is known as open economy. Most of countries are open economies. The closed economy is the term used for a country which has no economic relations with the rest of the world.

Sectorization of an Economy

  • There are three basic economic activities which is production, consumption and investment. Person who perform these activities are called producers (or production units), consumers and investors. This classification is based on the activities performed by those persons.

  • The consumer sector is further classified into households and government. Households comprise of all individuals and families who purchase or acquire goods and services for personal satisfaction of their wants. The government comprises of all government departments providing free services to the people. Such government departments are called General Government.

  • There is different motive behind the classification of consumers into households and general government. Households spend on consumption keeping in mind personal or family welfare. General government spends on consumption keeping in mind public or social welfare.

  • The borrowing and lending activities are grouped in a separate sector termed as the capital sector.

  • An economy is classified into four basic sectors i.e. production units, households, general government and capital. Another sector, the rest of the world, is added to take care of the flows among different countries.

    • Production units

    • Households

    • General government

    • Capital

    • Rest of the world.

Inflows and Outflows Among Different Sectors

We now learn the nature of flows that take place between different sectors.

Inflows and outflows among different sectors

Image of Inflows and Outflows Among Different Sectors

Flows from and to the Production Units

  • They buy factor services from households (real inflow). In return they make factor payments in the form of wages, rent, interest and profits (money outflows).

  • They deposit savings in the capital sector (mo11ey outflow).

  • They import goods and services (real inflow) and in return make payments for imports (money outflow).

  • They export goods and services (real outflow) and in return they get payments for the exports (money inflow).

  • They pay taxes to the general government (money outflow).

  • They sell goods and services to the households and general government (real out flow). In return they get payments from households (private consumption expenditure) and general government (government consumption expenditure) (money inflows).

  • They receive subsidies from government (money inflow).

  • They borrow from the capital sector (money inflow).

Flows from and to the Households

  • They buy goods and services from the production units (real inflow) and in return make payments (consumption expenditure) a money outflow).

  • They pay personal taxes to the general government (money outflow).

  • They deposit savings in the capital sector (money outflow).

  • They sell factor services to the enterprises (real outflow) and in return get factor incomes (money inflow).

  • They get free services (real inflow) and transfer payments (money inflow) from general government.

Flows from and to the General Government

  • It purchases goods and services from production units (real inflow) and in return makes payments i.e. government consumption expenditure (a money outflow).

  • It pays subsidies to the production units (money outflow).

  • It provides free services to the households (real outflow) and makes transfer payments (money outflow).

  • It deposits savings in the capital sector (money flow).

  • It receives taxes from production units (money inflow).

  • It receives personal taxes from households (money inflow).

Flows from and to the Capital Sector

  • It lends capital to the production units (money outflow).

  • It receives savings from production units, households and general government (money inflows).

Flows from and to the Rest of the World

  • Goods and services are exported to the rest of the world (real inflow) and in return payments are received (money outflow).

  • Goods and services are imported from rest of the world (a real outflow) and in. return payments are made (money inflow).

There are many flows which has no impact on the generation of national income. Which has no effect on national income.

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