Economic Basics - The Circular Flow of Income

Firms produce goods and services on demand for the government, households and other countries to consume. They provide employment, generate income and create demand within economy. They act as cornerstone for yearly GDP (Gross Domestic Product) determination. Government collect taxes on sale of the goods (VAT) and levied taxes to maintain public sector spending and investments. The biggest leakage is transfer payments: pensions, unemployment benefits where payments are made for no actual service. Money is circulated back to firms to produce more goods and services. Households receive payments in a form of wages and salaries, dividends, shares or rent for supplying labour, capital and land; where a government takes a small portion in form of direct and indirect taxes (money leakage for the cycle). Household income is spending for domestically and internationally produced goods and services. In the first instance money is circulated back to the cycle on the second money flows away from it. Some portion is saved either using financial institution (active capital) or non financial institution (passive capital - withdrawal from the cycle). The more households consume the faster the entire cycle flows nonetheless active savings are crucial as they provide more trust for financial institutions about economical health and liquidity for further injections