The five sector model/circular flow of income

Summary

In this video, Mr. Simons explains the Five Sector Model, also known as the Circular Flow of Income Model, which simplifies the complex workings of an economy into five interacting sectors: households, firms, financial sector, government, and international sector. He outlines the flows of labor, income, goods, services, taxes, and savings between these sectors, and introduces the concepts of injections (investment, government spending, exports) and leakages (savings, taxes, imports). The balance between injections and leakages determines whether the economy expands, contracts, or remains in equilibrium.

Takeaways

• 🌐 The five-sector model is a simplified representation of an economy's operations, helping to understand the interconnections between its parts.
• 🏠 The two-sector model involves households providing labor to firms and receiving income in return, and spending that income on goods and services provided by firms.
• 🏦 The three-sector model introduces the financial sector, where households deposit savings, and the financial sector lends to firms for investment.
• 🏛️ The four-sector model adds the government sector, which collects taxes from households and spends on various economic activities.
• 🌍 The five-sector model includes the international sector, where households buy imports and local firms sell exports.
• 💼 Households and firms are the foundational sectors in the model, with households providing resources and firms providing income and goods/services.
• 💹 The financial sector plays a critical role by channeling household savings into business investments.
• 💵 The government influences the economy by collecting taxes and spending on public goods and services.
• 🔄 The model shows that the economy is in equilibrium when injections (investment, government spending, exports) equal leakages (savings, taxes, imports).
• 📈 Economic growth occurs when injections exceed leakages, while economic contraction happens when leakages exceed injections.
• 🔄 The circular flow of income model illustrates the dynamic interactions between different sectors of an economy.

Q & A

What is the five sector model?

The five sector model, also known as the circular flow of income model, is a simplification of how an economy operates. It helps us understand the links between different parts of an economy by dividing it into five sectors and showing how they interact.

What are the five sectors in the model?

The five sectors in the model are households, firms (businesses), the financial sector (including banks), the government sector, and the international or overseas sector.

How does the two sector model work?

In the two sector model, households provide labor to firms in exchange for income, and firms provide households with goods and services in exchange for expenditure (spending).

What role does the financial sector play in the three sector model?

In the three sector model, the financial sector acts as an intermediary between households and firms. Households deposit savings into the financial sector, which then lends this money to firms and businesses for investment and growth.

How does the government sector contribute to the four sector model?

The government sector in the four sector model collects taxes from households and spends money in the economy. This spending can be on creating infrastructure, investing in industries, or other areas to stimulate economic activity.

What is the significance of the international sector in the five sector model?

The international sector represents the interaction between households and the global economy. Households buy imports (goods and services from overseas), and the international sector buys exports (goods and services from local firms).

What are injections in the context of the circular flow model?

Injections are economic activities that put money into the economy. These include investment, government spending, and exports. They help to grow and expand the economy.

What are leakages in the circular flow model?

Leakages are economic activities that take money out of the economy. These include savings, taxes, and imports. They can cause the economy to contract if they exceed injections.

What happens if injections exceed leakages in the economy?

If injections exceed leakages, it indicates that more money is being put into the economy than taken out, leading to economic growth and expansion.

What is the economic outcome when leakages exceed injections?

When leakages exceed injections, more money is being taken out of the economy than put in, which can cause the economy to contract or shrink.

What does it mean for the economy to be in equilibrium according to the model?

Economic equilibrium occurs when injections equal leakages, meaning there is no net growth or contraction. The economy is stable and neither expanding nor shrinking.

Outlines

00:00

🌐 Introduction to the Five Sector Model

Mr. Simons introduces the concept of the Five Sector Model, also known as the Circular Flow of Income Model. This model is a simplification of an economy's complexities, aiming to illustrate the interactions between different parts of an economy. The video begins with the Two Sector Model, which includes households and firms. Households provide labor to firms and receive income in return. Additionally, households spend money on goods and services provided by firms. The model then expands to include the Financial Sector, represented by banks, which accept savings from households and lend to firms to facilitate growth. The summary emphasizes the interconnectedness of these sectors and sets the stage for the introduction of the remaining sectors.

05:03

🏦 Adding the Financial and Government Sectors

The script continues by incorporating the Financial Sector into the model. Households deposit savings with the financial sector, which then lends to firms for investment. This is represented by the flow of money from households to the financial sector and then to firms. The Government Sector is introduced next, with households paying taxes to the government and the government spending in the economy. This spending can be on infrastructure or investments in various industries. The Five Sector Model is completed by adding the International or Overseas Sector, which involves households buying imports and the international sector buying exports from local firms. The video script explains the concepts of injections (investment, government spending, exports) and leakages (savings, taxes, imports) within the model.

10:04

🌍 The Dynamics of Injections and Leakages

The final paragraph discusses the economic dynamics of injections and leakages. Injections, such as investment, government spending, and exports, are money being put into the economy, which can stimulate growth. Leakages, including savings, taxes, and imports, are money being taken out of the economy. The balance between injections and leakages determines the state of the economy: if injections exceed leakages, the economy expands; if leakages exceed injections, the economy contracts; and if they are equal, the economy is in equilibrium. The video concludes by inviting viewers to ask questions in the comments and thanking them for watching.

Keywords

💡Five Sector Model

The Five Sector Model is an economic model that simplifies the complex workings of an economy into five distinct sectors to better understand their interactions. In the video, it is used to illustrate how different parts of an economy are interconnected, starting from the basic two-sector model and expanding to include more sectors such as the financial and government sectors.

💡Circular Flow of Income Model

The Circular Flow of Income Model is a visual representation of how income circulates within an economy. It shows the flow of money between households and firms, and how it is influenced by injections and leakages. The model is central to the video's theme, as it helps to explain the dynamics of economic activity.

💡Households

In the context of the video, 'households' represent one of the primary sectors in the Five Sector Model. They interact with firms by providing labor and receiving income, as well as spending money on goods and services. Households also interact with the financial sector by depositing savings and paying taxes to the government.

💡Firms/Businesses

Firms or businesses are another key sector in the model. They provide goods and services to households in exchange for income. Firms also receive investments from the financial sector, which helps them grow and contribute to the economy. The video discusses how firms are integral to the circular flow of income.

💡Financial Sector

The financial sector is introduced as the third sector in the model. It includes banks and other financial institutions that facilitate the flow of money between households and firms. Households deposit savings, and the financial sector lends this money to firms for investment, as explained in the video.

💡Government Sector

The government sector is the fourth sector added to the model. It involves the collection of taxes from households and the spending of this money back into the economy. The video explains that government spending can be on various things like infrastructure or investments in industries.

💡Injections

Injections refer to the inflow of money into the economy, which can stimulate economic activity. In the video, injections are exemplified by investment, government spending, and exports. These are all ways in which money is pumped into the economy, potentially leading to growth.

💡Leakages

Leakages are outflows of money from the economy that can slow down economic activity. The video identifies savings, taxes, and imports as leakages. When leakages exceed injections, the economy contracts, illustrating the balance needed for economic stability.

💡Equilibrium

Equilibrium in the video refers to a state where injections into the economy are equal to leakages, resulting in a stable economy that is neither expanding nor contracting. It is a concept used to show the balance needed for a healthy economic environment.

💡Imports

Imports are goods and services that households buy from overseas. In the Five Sector Model, imports are considered a leakage because they represent money flowing out of the domestic economy. The video uses imports as an example of how the international sector interacts with the domestic economy.

💡Exports

Exports are goods and services sold by domestic firms to the international sector. They are considered injections into the economy because they bring revenue into the country. The video explains that exports contribute to the growth of the economy by adding money to the domestic sector.

Highlights

The five-sector model simplifies the economy into five interacting sectors: households, firms, financial, government, and international.

The two-sector model starts with households and firms, showing how households provide labor to firms in exchange for income.

Firms provide goods and services to households, while households give firms expenditure, which is spending on those goods and services.

The financial sector is added in the three-sector model, where households deposit savings into the financial sector, which then lends to firms.

Firms use these investments from the financial sector to grow and contribute to the economy.

The government sector enters the four-sector model, collecting taxes from households and spending in the economy on infrastructure and services.

The international or overseas sector completes the five-sector model, with households purchasing imports and overseas sectors buying exports from domestic firms.

Imports represent goods and services bought from overseas by households, while exports are sold by local firms to international buyers.

The model introduces the concept of leakages (savings, taxes, and imports) and injections (investment, government spending, and exports).

Leakages represent money taken out of the economy, reducing spending on goods and services.

Injections pump money into the economy, stimulating economic activity and growth.

If injections exceed leakages, the economy will expand as more money is circulating.

If leakages exceed injections, the economy will shrink as more money is withdrawn than injected.

When injections and leakages are equal, the economy is in equilibrium, with no growth or contraction.

The circular flow of income model helps explain how different sectors of the economy interact and impact overall economic activity.

Transcripts

hi I'm mr. Simons and in this video

we're going to talk about the five

sector model also known as the circular

flow of income model and we're going to

talk about what it is what it means how

do you draw it and then what does it

signify about an economy and our

understanding of the economy an economy

is a very complex thing so the way I

like to think about the five sector

model it is a simplification of how an

economy operates to try and help us

better understand what an economy is and

the links between different parts of an

economy so if you think about it an

economy has so many different components

and moving pieces and groups and

interests and trends and changes and the

list really really really does go on the

five sector model tries to narrow all of

this situation into five sectors and how

they interact with each other so without

any further ado let's get into the five

sector model and the best way to start

is to draw it and to see those

relationships and how each sector

interacts with each other all right

let's get into it okay so here we are

with the outline of the five sector

model the circular flow of income model

it's all the same so what we start with

is these two sector models so we start

here so essentially we're starting up

here with the two sector model in the

first two sectors we've got we've got

households on one side and firms

businesses on the other and this is our

two sector model what you'll see is that

we add a sector each time and that this

is what creates the five sector model

we're going to look at the flows between

these two groups and we'll put this same

flows in the same color so if we look at

households households interact with

firms so we'll do this going up here

coming down here interacting here so

households two firms is that households

provide resources to firms and

households typically provide

laborer to firm and then in return that

firms provide households with income so

in exchange for the labor that

households provide firms provide income

now there is also another set of flows

that go between these two groups so that

if we think about the result of that

process there we can put this over here

is that firms firms provide households

with goods and services from production

in exchange for those goods and services

households provide firms with

expenditure expenditure is just a fancy

word for spending let's just put that

over there that households spend their

money with firms and businesses in

exchange for those goods and services so

each of these flows are linked so you

can see that there is a distinct

relationship between households and

firms and businesses so that's our two

sector model let's then move on to the

three sector model so what we're going

to do is we're going to add an extra

sector we're gonna add the financial

sector into our model of the economy now

the financial sector I think the best

way to think about this is to consider

that we are adding banks into our model

of the economy so that what we can say

here and let's maybe choose green and

use green yet so far that households

give money to the financial sector and

then the financial sector gives money to

firms and businesses so these are the

flows that exist so what happens is that

households will deposit their savings

into the financial sector and then the

financial sector will then lend this

money to firms and businesses so that

the financial sector will then invest

this money in firms and businesses

allowing them to expand and to grow and

to contribute so on this side households

deposit their savings on this side the

financial sector invests in firms and

businesses okay so this here is the

three sector model we add the financial

sector let's move on shall we so that

what we've got now is that we are going

to add we're going to add the government

sector into our model and so the

government sector is well would you

believe the government and that they are

playing a role in the economy so let's

use red because you know always will

chair for the government so then the

households have an flow here that

households will pay tax to the

government the day will take money out

of the economy and pay it to the

government and then the government now

it's not directly to firms and

businesses that's more in terms of the

whole economy but remember we're just

simplifying things with this model so

that if we look at this relationship

that the government will spend so that

on one side the government is collecting

tax from households on the other side it

is spending money in the economy and

this spending could be on all sorts of

things that could be creating new roads

it could be investing in different

industries itself all sorts of things so

when we add the government we create the

fourth sector model so we've gone from

the two sector model three sector four

sector to now the five sector model and

so the fifth sector the International or

overseas sector doesn't really matter

how you refer to that it's either one of

those is perfectly fine so let's say

that we grab silver here so that here

what we're saying is that households

they interact with the international or

the overseas sector by being by buying

goods and services from overseas so what

we're saying is that households by

imports from overseas and that if we

look at imports let's say this is two

stars and we can put this up here that

imports and M is just the symbol for

imports and I'll go through these

symbols in just a second

that's goods and services bought from

overseas and then if we're looking at

how does the international sector

interact with domestic firms so local

businesses that what we're saying here

is that what happens is they buy exports

from Australian firms and what we'll do

is we'll put three stars and put that

over here that if we look at it exports

X is goods and services bought from

local firms by the overseas sector so

we've got households spend their money

on imports while the international

sector buys exports from local firms so

this is the five sector model now what

I'm going to do is I'm just going to

grab two different highlighters and

we're gonna highlight a couple of

different things this T and M and then

I'll go I J and X and so what we can say

here is that everything that is in blue

running out of space here that

everything in blue is a leakage and

everything in yellow is an injection and

I'll explain that in just one second

okay so that was the circular flow model

and where I just ended up in terms of

that discussion was in this distinction

between injections and leakages so

injections is like money being pumped in

to an economy we are injecting pushing

money in to the economy so when we look

at investment government spending and

exports they all represent money coming

in to an economy so for example

investment that is money being pumped

into the firm's from the financial

sector which they can then invest again

spend used to help grow the economy

government spending that is money that

has been put into the economy that will

accelerate economic activity and exports

that is revenue

for firms who are selling overseas again

another injection into the economy so

injections will grow the economy they

will expand the economy if we then think

about leakages

we've got savings so when households

take money out of the economy and put it

into the banks they're not going to be

spending that money so that will

represent a leakage from the economy

when households pay tax that is money

that would ordinarily maybe have been

spent and used to boost economic

activity instead that has been taken out

of the economy by the government and

there's no guarantee that the government

will actually spend that money itself so

tax is another leakage and then the

final thing is when households buy goods

from overseas when they buy imports that

the goods come into Australia but the

money leaves Australia so that is a

leakage from the Australian economy so

in terms of leakages you've got s plus T

plus M then what we do is we compare

these two things so if my injections are

greater than leakages the whole economy

will expand economic activity will grow

but if leakages exceed injections then

more money is being withdrawn from the

economy then is being put into it so the

economy will shrink it will contract and

then the final situation if injections

equal leakages we're in equilibrium

things are equal we're not growing we're

not slowing we are just at equilibrium

put any questions in the comments and as

always thank you very much for watching