The circular flow of income: Part II
It is assumed that there are neither injections of new purchasing power into the flow nor leakages out of it. In such a case, total income in each period would be equal to the spending arising from incomes in the previous period.
IT IS a simple model of a static economy (having only two sectors: households and firms). It is based on the assumption of a one-period lag between income and expenditure. It is assumed that there are neither injections of new purchasing power into this flow nor leakages out of it. In such a case, total income in each period would be equal to the spending arising from incomes in the previous period and total income would remain constant over time. This is how we define something that is static.
But once the model also includes the government and the foreign sectors, injections of new purchasing power not derived from last period’s income can be made by investment, government spending, or exports. Leakages from the circular flow by which this period’s income does not lead to incomes in the next periods caused by saving, tax payments or imports. If injections and leakages are equal, income will be constant. If injections exceed leakages, income rise over time and if leakages exceed injections, income falls. All this can also be depicted schematically, but it is easier to show the impacts of leakages and injections mathematically.
Apart from a few assumptions that we have already mentioned, this two-sector model depends on some crucial assumptions that if not met, would severely constrain the various flows. These assumptions are briefly mentioned below:
Apart from a few assumptions that we have already mentioned, this two-sector model depends on some crucial assumptions that if not met, would severely constrain the various flows. These assumptions are briefly mentioned below:
- The producers and consumers do not perform their roles as economic agents in terms of choice-making;
- The axiom of Pareto-optimality is not met essentially in terms of the roles of the economic agents;
- There are no intermediaries between the primary producers and the ultimate demanders;
- There is no empowerment of the consumers;
- There is no controversy between protection and free trade;
- There is no asymmetric information of any kind; in other words both consumers and producers are fully informed of the various facets of market structures.
These assumptions are essentially there to simplify the complicated theory of the circular flow if income, but at the same time they take us away from reality. For example, empowerment of consumers is highly essential in terms of the concept of consumer sovereignty.
Let us also look at the controversy between protection and free trade that had existed much earlier all over the world. Whenever we go to the market as sellers of a product or service, we desire a situation in which we do not face competition. Thus, we ask for laws that outlaw foreigners and seek high tariff walls against them. We, thereby, invoke the doctrine of scarcity. On the other hand, when we go to the market as prospective buyers of a product or service, we seek a situation in which there are huge numbers of competing sellers of the product or service in question, so that there is keen competition, and we can arrive at attractive bargains and thereby, obtain both better prices as well as quality. In this capacity, we welcome free trade because it gives us the best the world has to offer. Thus, as buyers, we invoke the doctrine of abundance. From this logic, it becomes fairly clear that, if the state frames policies that are in accord with our instinct as sellers, then there will be high tariff walls and all of us will feel happy when we go to the market with our offerings. However, this means adherence to the doctrine of scarcity and so on, after we have sold our product, when we go to exchange what we have received to satisfy our consumption needs, we lose terribly.
In the present times, we must realise that these scarcity invoking policies were designed to keep clients happy. These clients prospered while the people stayed poor. This was not economics. It was cheap, thieving politics.
Let us also look at the controversy between protection and free trade that had existed much earlier all over the world. Whenever we go to the market as sellers of a product or service, we desire a situation in which we do not face competition. Thus, we ask for laws that outlaw foreigners and seek high tariff walls against them. We, thereby, invoke the doctrine of scarcity. On the other hand, when we go to the market as prospective buyers of a product or service, we seek a situation in which there are huge numbers of competing sellers of the product or service in question, so that there is keen competition, and we can arrive at attractive bargains and thereby, obtain both better prices as well as quality. In this capacity, we welcome free trade because it gives us the best the world has to offer. Thus, as buyers, we invoke the doctrine of abundance. From this logic, it becomes fairly clear that, if the state frames policies that are in accord with our instinct as sellers, then there will be high tariff walls and all of us will feel happy when we go to the market with our offerings. However, this means adherence to the doctrine of scarcity and so on, after we have sold our product, when we go to exchange what we have received to satisfy our consumption needs, we lose terribly.
In the present times, we must realise that these scarcity invoking policies were designed to keep clients happy. These clients prospered while the people stayed poor. This was not economics. It was cheap, thieving politics.
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