What are the main features of the five sector circular flow model? How is equilibrium achieved and what implications does this have for policy makers?

Essay by maxludoHigh School, 12th gradeA-, March 2004

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The five-sector circular flow model represents an open economy like Australia's, and demonstrates the important relationships between the different sectors in the Australian market economy. It is the last circular flow model because it does not have any assumptions that need to be left out such as governments and trade. The five parts of the model: households, firms, finance, Government and overseas sectors work collectively to form the economy. The inter-relationships between these sectors create market economic conditions that affect every Australian.

The model of the economy demonstrates that it literally works as a flow or a cycle. It can the be further defined to include two flows, one, a flow of goods and services and the other, a flow of money. The flow diagram demonstrates that when one sector is at risk it puts economic market conditions in jeopardy because they are all reliant upon one another. The Australian Economy is open, which is its open to flows of goods, services and capital from overseas using different currencies (with fixed exchange rates).

In the open economy income is used for consumption, savings, tax or spent on imports.

The new feature in the five-sector model is the overseas sector that includes imports and exports - Trade. The same principles apply to this model as the imports are represented as spending, however the money goes out of the economy. Money spent on imports by households or firms reduce income spent in the economy and are therefore classified as 'leakages' from the model. Imports can be categorised as the consumption of goods and services from the rest of the World and they reduce income, expenditure, output and employment from the Australian market economy. Importing goods mean that fewer Australian resources are utilised and production falls. Thus, the level of income decreases and...