Money flows into and out of the economy. The circular flow diagram explains how money moves through the economic system involving households, businesses, the government, and foreign agents (Editorial Board, 2011). Circular flow diagrams are visual models that show firms who employ workers, the workers then spend on goods produced by firms, and the money is then used to compensate the worker and buy raw materials to make the goods and the circle continues. Closed System
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Closed system economies only count domestic exchanges. That is exchanges with no imports or exports from other countries. This type of economy is self sufficient. This type of economy is usually free of leakage but may have leaks. A close example of a closed system would be North Korea. North Korea is cutoff from the world’s economy. In this country most property belongs to the state, the government controls almost every part of the economy (sets production levels), the state directs all significant economic activity, is regulated heavily by the states control, financial sector is controlled by the state, and formal trade is minimal (mainly with China and South Korea) (North Korea, 2013). North Korea is a perfect example of a closed system.
Things are worked out within the economy. The government has almost total control of the economy and everything that happens. Out of 186 countries with eight countries not ranking at all, North Korea comes in last at number 177 and an overall freedom score of a low 1.5. In the closed-system economy, cash flows in and out from business and consumers within that country. Households sell resources (land, labor, capital), which become inputs to the business.
The business incurs cost by paying for resources which becomes income to the households in wages and rents. On the bottom half of the closed-system circular flow diagram businesses sell goods and services to households who buy the goods and services which becomes revenue to the businesses. Open System
An open system economy counts goods and services that are exchanged
domestically and between nations (Editorial Board, 2011). With an overall score
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of 89.3 and ranked number 1 for the 19th consecutive year and in the 2013 economic freedom index, Hong Kong takes the top as a free open system economy in the Asia-Pacific region as well as in the world. Hong Kong participates in global trade and investments and has high economic growth and is a very competitive financial and business center (Hong Kong, 2013). The economy is prosperous as offers low taxes and light regulation. Hong Kong has a zero tariff rate and minimal non-tariff barriers. The country has an aggressive financial market and is greatly capitalized. As of October 2012 it had a trade balance of 3.9%, a GDP growth rate of 5.0%, and a GDP per capita of $34,457 (Hong Kong, 2012).
Cash flows in and out from business who trade with each other and the consumer who buy from the businesses. Households and firm interact in the goods and services market as well as the factor market. Households buy goods and services while firms sell the goods and services. Households sell land, labor, raw material, machines capital, and entrepreneurship while firms buy the inputs. So, households sell the land, labor, and capital to the firms who buy it then they sell the goods and services to the households who pay for them. The firms pay wages and rents to households who pay firms for the goods and services.
GDP is spending done by households that buy that goods and services produced by firms, total revenue earned by firms selling goods and services to households, wages, rents, and profits earned by households, and total income of households owing to payment by firms. Households and firms pay a tax which goes to public projects while the government offers services to the households and firms. Good and services are exported from the rest of the world.
In an economy leakages are imports, taxes, and even savings that are not spend in the economy (Editorial Board, 2011). In the open-system there are leakages for example when Americans buy imports or hire employees that work in other countries. Another leak would be when Americans save money. The money goes to the financial sector who lends it to other households and businesses. A personal example of leakage for me is my savings.
That is a leakage because the money is not being used in the economy. Leakages withdrawal from the flow and injections is income injected into the circular flow. Injections are investment expenditures, government purchases, and export. When money is borrowed by households and firms they cause injections which increase the flow of income. Conclusion
Money flows in and out of the economy in many ways. Understanding how the economy’s money goes in and out can be helpful. There are leakages where money goes out of the economy and injections where money comes into the circular flow. This a simple diagram that can be used to show exchange of goods, services, and payments of a particular economic system.See More on Economics