IGCSE Economics Paper-1: Specimen Questions with Answers 6 - 6 of 10

Question number: 6

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Describe in Detail

What are the conditions of equilibrium in the circular flow in an open economy?

Explanation

  • In an open economy, a country participates in a foreign trade. The country exports and goods and services to the foreign market and receive payment from the foreign market. These payments transfer into the circular flow of the economy by government sector, business sector and household sector. The household sector receives payment for the services given to foreign sector. Business sector receives payment for exporting goods and services to the foreign market. Government sector export and import goods and services and transfer and receive payments from the foreign market.

  • The receipts and payments from all three sectors enter into the circular flow of the economy. The circular flow in an open economy can be shown in a diagram.

The Financial market

The Financial Market

  • The economy is in equilibrium when outflows are equal to inflows. i. e. exports are equal to imports. If exports exceed imports, the economy has a surplus in balance of trade.

  • If imports exceed exports, the economy has a deficit in balance of trade. In a four sector economy

——— (1)

  • Where Y National Income, C Consumption, I Investment, G government Expenditure, X Exports and M = Imports

  • But, amount of savings (S) and taxes (T) should be equal to investment expenditure and government expenditure.

———— (2)

From (1) and (2)

The equilibrium conditions in a circular economy are given as

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