Question

Economists sometimes describe the economy as having a "circular flow." In the most basic form of the circular flow model, companies hire workers and pay them wages. Workers then use these wages to buy goods and services from companies. How does the circular flow model explain the equivalence of the expenditure and income methods of valuing an economy?

Answer 1

Answer:

In this simple circular flow model of an economy, the valuing of an economy can be made through the expenditure approach and the income approach. This is because every expenditure that is made comes from income that is earned. You cannot spend on anything if you don't make any money.

Using the expenditure approach, this economy would be equal to:

Y = C + I

Y is the total value of the economy, or output.

C is consumption from workers

I is investments from firms

And using the income approach, this economy would be equal to:

Y = W + P

Y is the total value of the economy, or output.

W is wages

P is profits

These two equations result in the same value. This is because the wages workers earn is the money that they use to engage in consumption, and the profits firms make is the money that they use to engage in investment.