A.

In the circular flow model three sector economy, government intervention has also
been accounted for, although it is still assumed to be a closed economy where the
income flow is not influenced by any foreign sector. Besides the income and
expenditure of the households and business firms, government purchases or
expenditures and taxation also come into play. Here, government purchases are
injections into the circular flow, while, taxation is a leakage.

Firstly, considering the flow of income and expenditure between household sector and
the government, household sector pays income tax and commodity tax to the
government. On the other hand, the government also makes transfer payments to the
household sector in the form of various benefits and services like pension funds, relief,
sickness benefits, health, education, and other services.

The flow of income and expenditure between business sector and the government is
similar. Business firms pay taxes to the government, the government, on the other
hand, provides subsidies, makes transfer payments, and pays for the goods and
services it purchases from the business sector.

As stated earlier, taxes paid by the household and the business sector are the leakages
from the circular flow. This decreases not only the consumption and savings of the
household sector, but also investments and production of the business sector
decreases.

However, the government offsets the leakages by buying services from the household
sector, and goods and services from the business sector. This leads to equilibrium in
the circular flow as the level of demand meets the level of supply in the economy.

A part of the income earned by the government is saved and deposited in the capital
market. Government also takes loans from the capital market either to meet the current
expenditure or to invest in different projects.
 Household sector provides the factors
of the production such as land, labour
and capital and enterprise that the
producers require to produce goods and
services. They also receive payments as
in rent, wages, interest and profits from
the business sector. It is also stated that
in general, household sector consists of the greatest number of consumers among all
sectors and satisfying the wants will cause consume of their climate aim.
Business sector act as a part as in receiving economy resources from household
sector and in exchange for consumer expenditure, they also provide household sectors
goods and services. Business sector is also given money to buy scarce economic
resources from the resource market. While theyre in the product market, business
sector sells their products and services, which is also the way they receives their
income.
To complete the circular income of income and expenditure in a three-sector closed
model, the government sector is added. Taxation is a leakage from the circular flow
and government purchases are injections into the circular flow. To do so, government
sector implements taxes on businesses and consumers. They also act as a part to spend
the money back on business and consumers for the other sectors benefits. Government
incurs expenditure on goods and services.
The circular flow between the household sector and the government sector:
Household sector pay direct taxes and commodity taxes in terms of building up the
leakage from the circular flow. On the other hand, government sector also purchase the
services from household sector and make transfer payments to the household sector
which has low income. All the expenditure is said to be injected into the circular flow.
The circular flow between the business sector and the government sector:
The action of business sector pay taxes to the government also constituting leakage
from the circular flow. Government sector will purchase the final goods from the
business sector as well as make transfer payments to firms to induce production from
the other sectors.
The circular flow among the household sector, business sector and government sector:
Taxation is a leakage from the circular firm. Taxation reduces savings and consumption
of the households. The reduction in consumption will reduce the sale and the income of
firms. The government offsets these leakages by making purchases from the business
sector and the household sector. It equal to the amount of taxes and total sales again
equal production of firms. The equilibrium will show in the circular flows of income and
the expenditure too.
The diagram above shows that taxes flow out of the household and business sectors
and go to the government. The government makes investment and the purchases
goods from firms and also factors of production from households. On the other hand,
government purchases of goods and services are an injection in the circular flow of
income and taxes are leakages.
If government purchases exceed net taxes, the government will incur a deficit equal to
the differences between the public expenditure and taxes. Besides, government
purchases will also cause a budget surplus when the net taxes are being exceeded.
When such situation occurs, the government will initiate reduce in the public debt. The
government also supplies funds to the capital market which are received by firms.
In a business, accounting is essential to measure the profit and loss of a company. It
keeps it as a business record for references to guide a company right on track. Similar
event apply to a nation GDP. The measurement incomes of a country are measured by
three different methods which consist of expenditure approach, income approach and
value added approach. These three methods must have the same results due to the
interrelation in the circular flow of production, income and expenditure.

B.

Externalities
In a market economy there are important differences between public and private
goods. Private goods are considered "rival and excludable" - one person consuming a
good means that another cannot, and those who do not pay for the good/service are
excluded from consuming them. In contrast, public goods are non-rival and non-
excludable; multiple people can enjoy them simultaneously and non-payers are not
excluded. This creates what is called the free-rider problem, an externality that means
that non-payers cannot be excluded from enjoying the good or service.

Externalities can be positive or negative, and they are often used as an example of
where government interference in the economy can do good. In all cases, externalities
are positive or negative effects that are not captured by the normal price mechanism of
a market economy. Companies that pollute, for instance, do not pay anything extra for
the damage they do to the environment. Likewise, those who work in their yard and
beautify their neighborhoods may increase property values for others with no direct
compensation back to them.

To deal with externalities, governments can use their powers of taxation and subsidy.
Taxation can be used to impose costs on negative actions (negative externalities) with
an eye towards reducing the occurrence and/or using the proceeds of the tax to
remediate the damage done. Likewise, a subsidy can encourage positive externalities to
continue and expand. In practice, however, there are considerable inefficiencies to
taxation and subsidies and they rarely produce the desired effects in a cost-effective
manner.
Externalities are not the only reason that governments impose taxes on their citizens.
Taxes fund government operations that range from the provision of collective services
(military and police services, courts, roads, etc.) to a variety of transfer payments that
are aimed at stabilizing economic activity (unemployment insurance and earned income
credits) and reducing poverty. (For more on the government use of taxes and spending,
check out What The National Debt Means To You.)

Taxes
When considering taxes, it is important to understand the difference between marginal
and average tax rates. Marginal rates refer to the tax rate in effect on the last dollar
earned, while the average tax rate is the product of total taxes paid divided by total
taxable income.

There are three major types of taxes in the U.S. tax system. Progressive taxes result in
higher average rates as income increases; personal income tax is a common
example. Regressive taxes result in lower average tax rates as income falls; sales tax is
commonly used as an example. Proportional taxes maintain a constant rate irrespective
of income. (To learn how taxes started in the US, see The History Of Taxes In The
U.S.)

Implications of Taxation and Government Spending

Broadly speaking, fiscal policy is the use of taxation and government spending for the
purposes of macroeconomic goals. Fiscal policy can be expansionary, that is aimed at
growing the economy and increasing employment, or contractionary (aimed at slowing
the growth of the economy). Expansionary fiscal policy features increased government
spending and/or decreases in the tax rates, while contractionary policy is the opposite
(lower government spending and/or higher tax rates).

Government economic actions are not without consequences, however.

When governments increase their spending, crowding out can occur government
spending reduces available funds and increases the cost of capital, leading many
businesses to abandon expansion projects. Likewise, when a government spends in
excess of receipts (a deficit) and must borrow funds to finance that deficit, crowding
out can occur.

Likewise, taxation causes problems of its own. Taxes shift the equilibrium for goods and
services away from its optimal level, therefore reducing consumer and producer
surpluses. This reduction is called the deadweight loss and it basically represents the
net benefit that is being sacrificed by society because of the presence of the tax. (For
more on government spending, read Do Tax Cuts Stimulate The Economy?)

Tariffs are levies charged by a government on imported goods. Tariffs are not as
significant to economies now as in years past; prior to the implementation of personal
income taxes, tariffs were a major source of U.S. government revenue. There are
principally two kinds of tariffs. Revenue tariffs are taxes levied on goods that are not
produced domestically, while protective tariffs are levied on goods that are produced
domestically.

As tariffs are essentially just a type of tax, there is deadweight loss here as well
consumers pay higher prices and consume less, and lose some of their consumer
surplus in the process. At the same time, domestic producers increase their output.

There are definite trade-offs between government spending and taxing. Dollar for
dollar, government spending has more impact than reducing taxes. This occurs because
consumers almost never have a marginal propensity to consume of "1" and almost
always withhold a portion of any tax cut and save it. (To learn more about tariffs, check
out The Basics Of Tariffs And Trade Barriers.)

Debt and Deficits

From a macroeconomic perspective, government debt can be thought of as future
spending brought forth into present time. Governments incur debt when their spending
desires exceed their receipts from taxes and other income sources, and that debt is
ultimately repaid through a levy of taxes in excess of current spending.

Government debt can become problematic through both a crowding-out effect and
through the deadweight loss of future taxation. When governments access debt
markets, they effectively crowd out other would-be borrowers (like corporations) and
force them to pay higher interest rates to attract willing creditors. With the higher cost
of capital that results, corporations abandon or reject expansion plans that would
otherwise have a positive expected economic return.

Governments have virtually no means of repaying debt other than through future
taxation. While there is a multiplier effect to government spending, high levels of
government debt essentially saddle future generations with the deadweight loss of
higher taxation with no offsetting multiplier to the GDP from government spending (as
that spending occurred years early when the debt was issued). (To learn more about
the deficit, see Breaking Down The U.S. Budget Deficit.)

C.
What is a 'Balanced Budget'

A balanced budget is a situation in financial planning or the budgeting process where

total revenues are equal to or greater than total expenses. A budget can be considered
balanced in hindsight, after a full year's worth of revenues and expenses have been
incurred and recorded. A company's operating budget for an upcoming year can also be
called balanced based on predictions or estimates.
BREAKING DOWN 'Balanced Budget'
The phrase "balanced budget" is commonly used in reference to official government
budgets. For example, governments may issue a press release stating that they have a
balanced budget for the upcoming fiscal year, or politicians may campaign on a promise
to balance the budget once in office. It is important to understand that the phrase
"balanced budget" can refer to either a situation where revenues equal expenses or
where revenues exceed expenses, but not where expenses exceed revenues.

Budget Deficits and Surpluses

The term "budget surplus" is often used in conjunction with a balanced budget. A
budget surplus occurs when revenues exceed expenses, and the surplus amount
represents the difference between the two. In a business setting, surpluses can be
invested back into the company, such as for research and development (R&D)
expenses, paid out to employees in the form of bonuses, or they can be distributed to
shareholders as dividends.

In a government setting, a budget surplus occurs when tax revenues in a calendar year
exceed government expenditures. The United States government has only achieved a
budget surplus -- or a balanced budget, for that matter -- four times since 1970. It
happened during consecutive years from 1998 until 2001.

A budget deficit, by contrast, is the result of expenses eclipsing revenues. Budget

deficits almost invariably result in debt being incurred. For example, the U.S. national
debt in excess of $19 trillion as of June 2016 is the result of accumulated budget
deficits over many decades.

D.
What is a 'Transfer Payment'

A transfer payment, in the United States, is a one-way payment to a person for which
no money, good, or service is given or exchanged. Transfer payments are made to
individuals by the federal government through various social benefit programs. These
types of payments are executed by the United States to individuals through programs
such as Social Security.

BREAKING DOWN 'Transfer Payment'

A transfer payment is a process used by governments as a way to redistribute money

through programs such as old age or disability pensions, student grants
and unemployment compensation. Transfer payments, however, do not
include subsidies that are paid to domestic farmers, manufacturers and exporters, even
though they are technically a one-way payment to a person on behalf of the
government.

Government transfer payments, although no services are performed, are considered to

be a component of personal income. These payments can be made at the federal, state
and local level of governments.

What Are Transfer Payments?

Government transfer payments span a wide range of uses and organizations. The funds
for these payments also come from many different sources. However, the most
common form of transfer payment is retirement and disability insurance benefits. These
payments are made to those who qualify for OASDI benefits, railroad retirement and
disability benefits, workers compensation programs and others.

Medical benefits are the second most common form of transfer payments. These types
of benefits are government payments made through intermediaries to beneficiaries of
medical care. Specifically, medical benefits come from either public assistance medical
care or military medical insurance benefits. Public assistance is received by low-income
individuals and payments come through the federally assisted, state-
run Medicaid program and the Children's Health Insurance Program (CHIP). Military
insurance is provided to military personnel through the TriCare Management Program.

Unemployment insurance is perhaps the third most common type of government

transfer payments. This insurance includes state unemployment, federal unemployment
and other organizations of unemployment compensation. Veterans' benefits are also a
fairly common form of transfer payment. Transfer payments that surround these types
of benefits are made up of veterans' pension and disability benefits, veterans' life
insurance benefits and other types of veteran assistance.

Finally, education and training assistance is considered a type of government transfer

payment. This government assistance consists of higher education student assistance,
interest payments on student loans and state educational assistance. The combination
of these benefits help individuals at all levels of education afford school. They also help
people from all types of backgrounds. From Individuals who may only need a loan to
people who need more assistance, all people can be helped with these transfer
payments.
E.
1. Government Expenditure Multiplier:

The Keynesian investment multiplier is in fact expenditure multiplier which measures

the rate of change in income due to a change in autonomous consumption expenditure

and autonomous investment expenditure,

K = 1/1-c

Similarly, government expenditure multiplier Kg is a change in income due to a change

in autonomous government expenditure.

It can be expressed as:

2. Tax Multipliers:

When the government changes the tax rates, the relation between disposable income

and national income changes. When the government increases a tax rate (T) or levies a

new tax, the marginal propensity to consume (c) of the people declines because their

disposal income is reduced. This brings a fall in national income due to the multiplier

effect. On the other hand, reduction in taxes has the multiplier effect of raising the

national income. The tax multiplier (KT) is

3. Balanced Budget Multiplier:

The balanced budget multiplier is used to show an expansionist fiscal policy. In this the

increase in taxes (T) and in government expenditure (G) are of an equal amount

(T=G). Still there is increase in income. The basis for the expansionary effect of this

kind of balanced budget is that a tax merely tends to reduce the level of disposable
income.

Therefore, when only a portion of an economys disposable income is used for

consumption purposes, the economys consumption expenditure will not fall by the full

amount of the tax. On the other hand, government expenditure increases by the full

amount of the tax. Thus the government expenditure rises more than the fall in
consumption expenditure due to the tax and there is net increase in national income.

The balanced budget multiplier is based on the combined operation of the tax multiplier
and the government expenditure multiplier. In the balanced budget multiplier, the tax

multiplier is smaller than the government expenditure multiplier. The government

expenditure multiplier is

Which indicates that the change in income (Y) will equal the multiplier (1/1c) times
the change in autonomous government expenditure.
The tax multiplier is

F.
What is an 'Income Tax'

An income tax is a tax that governments impose on financial income generated by all
entities within their jurisdiction. By law, businesses and individuals must file an
income tax return every year to determine whether they owe any taxes or are eligible
for a tax refund. Income tax is a key source of funds that the government uses to fund
its activities and serve the public.

BREAKING DOWN 'Income Tax'

Most countries employ a progressive income tax system in which higher-income earners
pay a higher tax rate compared to their lower-earning counterparts. The first income
tax imposed in America was during the War of 1812. Its original purpose was to fund
the repayment of a $100 million debt that was incurred through war-related expenses.
After the war, the tax was repealed, but income tax became permanent during the early
20th century.

A progressive tax is a tax in which the tax rate increases as the taxable amount
increases.[1][2][3][4][5] The term "progressive" refers to the way the tax rate progresses
from low to high, with the result that a taxpayer's average tax rate is less than the
person's marginal tax rate.[6][7] The term can be applied to individual taxes or to a tax
system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an
attempt to reduce the tax incidence of people with a lower ability to pay, as such taxes
shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a
progressive tax is a regressive tax, where the relative tax rate or burden decreases as
an individual's ability to pay increases.[5]