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What Are The Main Features Of The Five Sector Circular Flow Model? How Is Equilibrium Achieved And What Implications Does This Have For Policy Makers?

970 words - 4 pages

The five-sector circular flow model represents an open economy like Australia's, and demonstrates the important relationships between the different sectors in the Australian market economy. It is the last circular flow model because it does not have any assumptions that need to be left out such as governments and trade. The five parts of the model: households, firms, finance, Government and overseas sectors work collectively to form the economy. The inter-relationships between these sectors create market economic conditions that affect every Australian.The model of the economy demonstrates that it literally works as a flow or a cycle. It can the be further defined to include two flows, one, a flow of goods and services and the other, a flow of money. The flow diagram demonstrates that when one sector is at risk it puts economic market conditions in jeopardy because they are all reliant upon one another. The Australian Economy is open, which is its open to flows of goods, services and capital from overseas using different currencies (with fixed exchange rates). In the open economy income is used for consumption, savings, tax or spent on imports.The new feature in the five-sector model is the overseas sector that includes imports and exports - Trade. The same principles apply to this model as the imports are represented as spending, however the money goes out of the economy. Money spent on imports by households or firms reduce income spent in the economy and are therefore classified as 'leakages' from the model. Imports can be categorised as the consumption of goods and services from the rest of the World and they reduce income, expenditure, output and employment from the Australian market economy. Importing goods mean that fewer Australian resources are utilised and production falls. Thus, the level of income decreases and the flow of money becomes smaller. Eventually however the flow would return to equilibrium but at a lesser rate and the circular flow would have contracted.Furthermore, exports of goods and services generate income for exporters from overseas households or firms who pay for these exports. An Australian export is essentially a product or service that is produced here and sold to another country generating income for Australian businesses. Exports are therefore a form of injection of income into the circular flow without using Australian resources to produce them. With both imports and exports taking place as the new addition to the five-sector economy the circular flow is again complete. All income is consumed, saved, taxed and now can be used to purchase imports.The economy is in equilibrium when income equals output equals expenditure or simply, Injections equal Leakages. The open economy will be in equilibrium when savings plus taxation plus imports equals investment plus Government spending plus exports. However, this does not mean that savings has to equal...

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