Circular Flow Model

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The circular flow of income model is a theoretical representation of the economy. It shows the distribution of income within the economy and the interaction between the different sectors in a modern market economy. The five-sector model is a more elaborate model in comparison to the basic, two, three and four sector models. The model represents an economy like Australia and divides the economy into five main sectors.

The first sector in the model is the Households sector. This sector refers to all individual members in the economy. All individuals of an economy are consumers. Consumers are concerned with earning an income for themselves and spending on goods and services. Households supply factors of production i.e. land, labour,
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Thus, there are no more significant assumptions are associated with the five sector model.
In the circular flow of income model of the economy, when total injections exceed total leakages, the circular flow grows, resulting in economic prosperity. When total leakages exceed total injections, the economy is said to be in recession.
Equilibrium in the circular flow model is a state where the total value of injections is equivalent to the total value of the leakages. Thus, there is no tendency for the flow to change as the outflow matches the inflow and the model is balanced. For equilibrium to occur, the total leakages that is, savings plus taxation plus imports, must be equal to the total injections that is, investment plus government spending plus exports. However, there is no necessary reason why an economy must achieve or maintain equilibrium.
If the level of economic activity happens to be too low that a high level of unemployment is generated, a net injection into the economy would be desired to raise the level of national income. If the level of economic activity is so high as to cause inflation, then a net leakage out of the economy would be desired to lower the national income.

The circular flow model and the concept of equilibrium can be applied to the real world. Factors that may influence the amount of leakages out of the economy or the amount
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