Subject:- Managerial Economics 2

Course Code:-ECOM518
CA:- 01
Instructor:- Dr Tawheed Nabi
Section:- Q2154

Mittal School Of Business

Lovely Professional University
Phagwara, Punjab
 Annexure-V- Cover Page for Academic Tasks

Course Code: ECOM518 Course Title: Managerial Economics 2

Course Instructor: Dr. Tawheed Nabi

Academic Task No.: 01 Academic Task Title: Assignment

Date of Allotment: 30.08.2022 Date of submission: 12.09.2022

Student’s Roll no: A13 Student’s Reg. no: 12110909

Evaluation Parameters: (Parameters on which student is to be evaluated- To be mentioned by

students as specified at the time of assigning the task by the instructor)

Learning Outcomes: (Student to write briefly about learnings obtained from the academic
tasks)

Declaration: I declare that this Assignment is my individual work. I have not copied it from
any other student‟s work or from any other source except where due acknowledgement is made
explicitly in the text, nor has any part been written for me by any other person.

Student’s Signature: Robiul Islam Akash

Evaluator’scomments (For Instructor’s use only)

General Observations Suggestions for Improvement Best part of assignment

Evaluator‟s Signature and Date:

Marks Obtained: Max. Marks: …………………………

 Topic:- Illustrating Graphically the circular flow of income and
expenditure in a four sector model

Introduction:- The circular flow of income is an economic model that reflects how money
or income flows through the different sectors of the economy. A simple economy assumes that
there exist only two sectors, i.e., Households and Firms. Households are consumers of goods
and services and the owners of the factors of production (land labour, capital, and enterprise).
However, the firm sector produces goods and services and sells them to households.
In the circular flow of income (two-sector economy), there is an exchange of goods and services
between the two players i.e., the firms and households, which leads to a certain flow of money
in the economy. Households provide the firms with the factors of production, namely Land
(Natural Resources), Labor, Capital, and Enterprise that generates goods and services, and
consumers spend their income on the consumption of these goods and services. The firms then
make factor payments to households in the form of rent, wages, interest, and profit. This flow
of goods and services and factors payments between firms and households reflects the circular
flow of money in an economy.

• Firms are the producers of goods and services, and therefore, they require various
production or societal resources to produce goods and services.
• The factors of production are land, labour, building, stock, stationery, etc.
• Households provide the resources or factors of production. For example, a household
provides land and labour to carry out business operations in exchange for the money
paid in rent, wages, etc.
• So, the money flows from the firms to the household in rent, wages, etc.
• The households utilize wages and rent to purchase certain goods and services to fulfill
their needs and wants.
• When the households pay for these goods and services, the money flows back to the
firms, completing the circular movement of money.

The Four Sector Circular Flow Income Model is the most realistic one under the current world
conditions. In our earlier discussions, we have seen the other Models also – Two Sector and
Three Sector. However, the Three Sector Model represented a closed economy which is no
more relevant in current times. The Four Sector Model does away with this shortcoming. And
foreign transactions are also included and integrated into this Model. In a circular flow of
income, every sector plays a dual role. Each sector not only gets a payment from other sectors
but pays them as well in one form or another. Thus, understanding the circular flow of
income and expenditure in an economy is very important, and one of the best models that
explain it is the four-sector model. This model is realistic and practical as it consists of four
primary sectors. These sectors are households, businesses, the government, and the foreign
sector (or the rest of the world). The foreign sector primarily means the export and import of
goods and services. Therefore, this Four Sector Model is also called an Open Economy Model.
In the Four Sector Model, imports are treated as expenditure and become a leakage. Whereas
exports boost the national income.

Assumptions of the Four Sector Model

• This model drops the unrealistic assumptions of the two- and three-sector models.
Following are the assumptions of a four-sector model:
• The entry and recognition of the Foreign Sector in this model leads to no restrictions
on the import and export in general. Specific restrictions like the trading country,
product, etc may be there.
• The Government intervention is minimal.
• Balance Of Tradeh domestic and foreign markets feature perfect competition.
• Household exports labour and capital, while businesses export goods and services.

Understanding Four Sector Model:-

Each sector’s role (income and expenditure) in detail to better understand the four-sector
model.

Household Sector
The Household Segment plays a critical role in the Economic Development of any Country.
This sector acts as:
• A producer: Small businesses – self-employed and family businesses does make some
products and sell the same. And gets money from other sectors by selling these goods
and services.
• Works as a factor of production: They provide resources to the businesses as well as
the public in the form of labor, professionals-Doctors, Engineers, Lawyers,
Consultants, etc. They earn income in the form of rent on owned properties, fees, and
remuneration for the work and services provided to other sectors as well as to the
household segment.
• Transfer payments: This segment also gets various transfer payments from the
government in the form of subsidies, welfare activities, and so on.
 • Acts as a consumer: households consume various goods and services produced and sold
by the businesses. The major outgo of the household segment is in the form of
consumption only. They also pay for the imports of goods and services.
• Pays taxes to the Government: Besides the businesses, the households form a large
chunk, rather than the biggest chunk of taxpayers to the government. They pay direct
taxes in the form of income tax, wealth tax, gift tax, etc. They also pay indirect taxes in
the form of VAT, Sales Tax, Service Tax, GST, etc.
• Act as Saver: Households are the biggest block of savers and investors in an economy.
Every other segment-businesses and the government try to woe their savings. The
money left over from their income, after fulfilling all their consumption needs, is saved.
These savings get deposited with banks and financial institutions. Part of it also goes
for investment in the stock market, real estate, bullion, and so on.

Business Sector
Businesses get revenue from selling goods and services to households, as well as through
exports. They also get subsidies from the government. On the other hand, payments from
businesses to other sectors include factor payments, taxes, import payments, and more.
Government Sector
The segment includes two types of activities. The First one is the governance, welfare activities,
services, and so on. The second segment is where the government owns and operates certain
businesses.
The primary income source for the government is tax collections from households and
businesses. Also, the government gets interests and dividends from investing in businesses, as
well as international grants and loans. On the other hand, payment from the government
includes transfer payments, subsidies, grants, and more. The transfer payments involve sending
money to households through pension funds, scholarships, and more. Also, the government
buys goods and services from businesses.

Foreign Sector
This sector gets income from businesses, governments, and households who import goods and
services from other countries. On the other hand, the foreign sector makes payments to
businesses and governments when they export goods and services to other countries. It also
makes factors payment to households. In the case of exports being more than imports, there is
a surplus balance of payment. And, when the imports exceed exports, there is a deficit balance
of payment in the economy. The government uses different policies to maintain a balance
between imports and exports.

Determination of Equilibrium Output/Income

We can use the four-sector model to determine the equilibrium income/output in an economy.
Using the aggregate expenditure
method, we can get the equilibrium
income/output by adding the
expenditure from all four sectors.
So, equilibrium income/output = C
+ I + G + (X – M)
Here ”C” is the household
expenditure, ”I” is a business
expenditure, ”G” is government
purchase, while ”X – M” is the net
foreign demand or
”Exports less Imports.”
If other things remain the same, the income and output in an economy will go up with a rise in
exports and a drop in imports. And, the income and output level in an economy will drop if
there is a jump in imports and a drop in exports.

Balance of Trade

The balance of trade , also known as

the trade balance, refers to the
difference between the monetary
value of a country’s imports and
exports over a given time period. A
positive trade balance indicates a
trade surplus while a negative trade
balance indicates a trade deficit. The
Balance Of Trade is an important
component in determining a country’s
current account.

Formula
The formula for calculating trade balance is as follows:

Where:
Value of Exports is the value of goods and services that are sold to buyers in other countries.
Value of Imports is the value of goods and services that are bought from sellers in other
countries.

Interpretation of Balance Of Trade for an Economy

To the misconception of many, a positive or negative trade balance does not necessarily
indicate a healthy or weak economy. Whether a positive or negative Balance Of Trade is
beneficial for an economy depends on the countries involved, the trade policy decisions, the
duration of the positive or negative Balance Of Trade, and the size of the trade imbalance,
among other things.
In short, the Balance Of Trade figure alone does not provide much of an indication regarding
how well an economy is doing. Economists generally agree that neither trade surpluses or trade
deficits are inherently “bad” or “good” for the economy.
A positive balance occurs when exports > imports and is referred to as a trade surplus.
A negative trade balance occurs when exports < imports and is referred to as a trade deficit.

The Balance of Trade between the United States and China

The United States’ trade deficit with China remains a highly debated topic among policymakers
and academics. The US trade deficit has continued to rise over the years, increasing to a five-
month high in July 2018.
To many, the issue may seem problematic. However, there’s been no strong evidence that a
negative import/export balance is hurting the economy of the United States. In fact, the US
economy has been experiencing one of its longest expansions in history.

• The balance of trade refers to the difference between a country’s exports and imports.
• This trade figure alone does not provide much insight into the actual health of an
economy. (The US is an example of a country with a long-standing trade deficit but
that is currently experiencing one of its longest expansions in history).
• A positive BOT does not necessarily indicate a healthy economy, nor does a negative
one necessarily indicate a weak economy.

Indian Balance of Trade:-

India's trade deficit rose to USD 28.68 billion in August of 2022 from USD 13.81 billion in
the same period last year, a preliminary estimate showed. Imports jumped by 31% to USD
61.68 billion whereas exports decreased by 0.8% to USD 33 billion.

India has been recording sustained trade deficits since 1980 mainly due to the strong imports
growth, particularly of mineral fuels, oils and waxes and bituminous substances and pearls,
precious and semi-precious stones and jewelry. In recent years, the biggest trade deficits were
recorded with China, Switzerland, Saudi Arabia, Iraq and Indonesia. India records trade
surpluses with the US, United Arab Emirates, Hong Kong, United Kingdom and Vietnam.
Balance of Trade in India is expected to be -20.80 USD Billion by the end of this quarter,
according to Trading Economics global macro models and analysts expectations. In the long-
term, the India Balance of Trade is projected to trend around -9.60 USD Billion in 2023,
according to our econometric models.

Advantages of Trade Deficit

• The advantages of having the trade deficit are as follows:
• It allows a country to consume more than its production capacities.
• It helps nations to avoid any shortfall in goods.
• It provides the countries with a comparative advantage when such countries are
involved in the trade. It is beneficial as a whole for increasing global wealth.
• It allows generating more foreign direct investment

Disadvantages of Trade Deficit

• The disadvantages of the trade deficit are as follows:
• It is harmful to a developing country as more imports lead to deflation and increase
the fiscal deficit.
• More jobs are outsourced, as domestic industries shrink with less demand when
demand for foreign goods increases.
• In the form of attracting foreign investment due to the trade deficit, the country may
end up providing ownership of its resources and assets to the foreign country.
• A higher trade deficit leads to a decrease in the value of the local currency.
Reference:-
https://commerce.gov.in/
Dwivedi, K. N. (2012). Microeconomics. Pearson Education India.
Daraban, B. (2010). Introducing the circular flow diagram to business students. Journal of
Education for Business, 85(5), 274-279.
Guţă, A. J. (2013). The Models of Presentation of Ensemble Circular Flow of the National
Economy from the Provisional Science. Annals of the University of Petroşani.
Economics, 13, 93-98.