Circular Flow and Economic Growth

This assignment delves into the relationship between consumer behavior, producer actions, and government policy in shaping economic outcomes. It examines the circular flow diagram as a tool for visualizing income movement within a nation. The analysis specifically focuses on Australia's open economy, discussing how changes in exports and imports influence consumer spending and overall economic growth. Factors affecting consumer spending habits, such as saving rates and interest rate fluctuations, are also explored.

Running head: PRINCIPLES OF ECONOMICS
PRINCIPLES OF ECONOMICS
Name of the Student
Name of the University
Authors Note

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Table of Contents
Introduction......................................................................................................................................3
Question 1........................................................................................................................................3
Question 2........................................................................................................................................6
Question 3........................................................................................................................................8
Question 4......................................................................................................................................10
Conclusion.....................................................................................................................................13
References......................................................................................................................................14

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Introduction
The aim of this study is to analyze on the firms behavior under the imperfect competitive market
structures. In addition, market failure and imposition of government policy for controlling the
market is also illustrated in this paper. This study also discusses about the Australian circular
flow of income and various determination of GDP growth rate. The circular flow of income
helps in assessing the respective nation in terms of national income and product account (NIPA).
Moreover, the GDP, withdrawals and injections are also estimated from the national accounts
data for the hypothetical economy.
Question 1
a) Firms under monopolistic and oligopolistic competition resort to differentiation of products as
it facilitate them in earning higher profitability (Baumol and Blinder, 2014). Few entities in this
imperfect competitive market produce dissimilar products because they do not ability to imitate
the products of their competitors. Product differentiation makes the commodities more attractive
and aids the firms in attracting more customers. This aid the companies in gaining competition
advantage as these products becomes superior in the view of customers.
The restaurants in the monopolistic competitive market offer different food items to the
customers that possess some unique element within it (Friedman, 2017). On the other hand, cell
phones Company in the oligopolistic market such as Apple, Nokia differentiate their mobiles in
terms quality, innovative features and design. This strategy helps the firms in existing in the
competitive environment and expands their business globally.

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b)i) The framework of kinked demand curve assumes that the company’s will face commodities
dual demand curve based on rivalries reactions to the price change or other variable. The demand
curve of the oligopolistic competitive market according to the hypothesis of kinked demand
curve has ‘kink’ given the certain price level. The kink occurs at that price level prevailing in
the market because the demand curve segment above that present price level is elastic in nature
while the demand curve section below prevailing price is highly inelastic (Tinkler and Woods,
2013). In this case, the kink occurs at price $185 corresponding to the quantity demanded at 50.
At product price above $185 and amount less than 50, the demand curve becomes elastic.
However if the firm increases the product price, its rivalries will not change the price and its
quantity will decline. At prices below $185, demand curve becomes inelastic. This is because if
one entity declines its product price, others will also tend to decline their commodities price.
ii) Marginal revenue (MR) curve corresponding to this kinked demand curve consists of three
segments. If the quantities are less than 50, the MR curve is moderately flat. This section is
obtained from that segment of demand curve that is elastic that corresponds to higher price and
lower quantities (Taussig, 2013). On the contrary, if the product quantities are higher than 50, the
MR curve is steep. This section is attained from the demand curve portion that is inelastic
associated with higher quantities and lower product prices. In addition, the MR curve becomes
vertical at current price$185. Hence, this vertical section of the MR curve corresponds to kinked
point of demand curve.

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$185
Price
Quantity50
Demand curve
MR
Graph 1: MR curve
Source: (Authors creation)
iii) Maximization of profit is attained at the point where marginal revenue (MR) curve becomes
equivalent to marginal cost (MC) curve. The MC curve cuts the vertical portion of the MR curve
that corresponds to the equilibrium price $185 and equilibrium quantity 50.

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Quantity
Price MC
D
50
185
MR
Graph 2: Profit maximizing point
Source: (Authors creation)
Question 2
Market failure occurs when the products are not allocated in efficient way. Externality is one of
the main causes of market failure, as equilibrium price does not reflect actual cost and advantage
of commodities. Externalities also known as external cost exists in the market when prevailing
price does not detain social cost that is being inflicted in the society (Sloman et al., 2013).
Therefore, divergence arises between both private and social interest that leads to market failure.
Externalities in relation with environmental resources are substantial due to indirect cost that
individuals inflict on the society. For example, market failure occurs owing to external cost of
coal-fired power station. In the current situation, few users demand coal for their private

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QmQs
Pm
MSB MB
MC>MSB
MC
Deadweight loss
Quantity
Price
advantage and private cost. Moreover, demand for coal fired energy increases if its price fails to
detain external cost that has been obtained by the society namely environmental effects. In
addition, if the coal’s or energy’s market price is unable to capture social cost, indirect users face
incentives.
External cost of alcohol consumption means the spillover cost that affects the individuals owing
to consumption of alcohol. Alcohol has been considered as demerit product and hence
overconsumption of alcohol leads to negative externality. However, market failure occurs as all
cost are not considered by the consumer and this results to spill-over cost. This spill-over cost
affects other persons that declining societies benefit. This is illustrated with the help of the
diagram given below:
Graph 3: Market failure in the context of alcohol consumption

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Source: (Authors creation)
The figure reflects that the consumer considers their benefit and hence consumes at Qm at price
Pm where marginal cost is equivalent to marginal benefit (MC=MB). The spillover cost is shown
by lower MSB curve. Efficiency loss as consumption occurs at the point where MSB<MC and
thus resulting to deadweight loss.
b)i) An increase in excise tax on petrol helps in recovering the cost that has been inflicted on the
society by the road users. It is known as proxy cost for externalities as it aids in decreasing
congestion in the roads of Australia. One disadvantage of the imposition of excise tax is that the
amount paid by the user does not differ directly with social cost of using road.
ii) Bus and cycle lanes at peak times helps in reducing crashes and offers uninterrupted way for
the public transport and hence makes travel safer. One disadvantage is that it restricts to peak
hours as it cannot be designed easily for shifting utilization.
iii) Prepaid smart card as used in Singapore helps in reducing congestion as it takes less time for
the driver to estimate the amount to pay the charge when the vehicle moves under ERP
(Electronic Road Pricing ) gantry. One drawback of using this smart card is that it is expensive
and creates risk to the users of fake cards.
Question 3
a) Five sector model of circular flow mainly depicts open economy such as Australia. It
facilitates in demonstrating the vital relationship among various sectors in the market economy
(Rios et al., 2013). The inter relationship among the sectors generate market economic state that
influences ever people in the country (Reisman, 2013). The circular flow diagram signifies that if

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one sector faces risk, then it creates jeopardy in market conditions of this economy as they are
dependent upon each other. As it is an open economy, income is utilized for consumption, tax,
expenditure and on imports. Thus, the amount spent by the households on import of goods is
categorized as leakages. Moreover, investment is considered as injection and saving is denoted
as leakage in this circular flow diagram. Thus , income level declines if the money flow in the
nation becomes smaller.
i) Firms spending money on research and development is considered as net injections or
investment in the economy (Mankiw, 2014). This is because money spent on research helps the
firms in gaining knowledge for developing and designing the products and technologies in order
to enhance overall productivity. Thus it aids in increasing national income of Australia.
ii) Public investing more money in credit unions is considered as increase in savings or net
withdrawals. Credit unions pays back the amount invested by the public in form of high rate of
savings and low rate of loans (Murota and Ono, 2015). However, the aim of credit unions is to
increase the customers money and helping them to solve any financial related problem.
iii) It is considered as net injections as rise in government spending is not counterbalance by any
changes. However, more money is being printed in order to finance the investment if the
government runs s budget deficit.
iv) Australian investors earning higher dividends on overseas investment is considered as decline
in net withdrawals (Marshall, 2015). Overseas investment helps in diversifying their portfolio
and add benefits of higher economic growth. Therefore, net outflow of money reduces abroad
from domestic sectors.

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b)i) GDP refers to the final commodities and services that are produced within the geographical
boundary in particular time limit. The expenditure method estimates GDP as –
GDP= Private consumption+ investment (government + gross) + government expenditure on
consumption +net exports (Import – Export)
From the above table, GDP is calculated as –
Gross Domestic Product
(GDP=C+I+G+NX) 130000
ii)Withdrawals
Withdrawals (S+T+M) 41000
iii)Injections
Injections (I+G+X) 90000
Question 4
a) i) An inflationary gap also termed as expansionary gap explains the total amount by which
present level of nations real GDP (Gross domestic product) surpass expected GDP that the nation
experiences at full employment and is also known as potential GDP (Mankiw, 2014). This gap
occurs when the product and services demand exceeds factors production that includes overall
employment level, rising activities of trading. The figure below shows the inflationary gap-

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Full Employment Line
Inflationary gap
Y*Yf
E
A
B
AD’
AD(C+I+G+X-M)
National Output
Aggregate expenditure
Graph 4: Inflationary gap
Source: (Authors creation)
ii) Deflationary gap refers to the difference between the outputs at full employment level and the
original output (Bauer, 2014). It is defined as the measurement of aggregate demand deficiency
at full employment level. This gap is affected by the economic growth rate in comparison with
the growth rate trend in the long run. It is also termed as recessionary gap. The diagram below
reflects deflationary gap-

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National output
Aggregate expenditure
A
B
Deflationary gap
Y* Yf
Graph 1: Deflationary Gap
Source: (Authors creation)
The difference between the inflationary and deflationary gap is that inflationary gap occurs when
aggregate demand is higher than the aggregate supply (AD>AS) while deflationary gap arises
when aggregate demand becomes less than aggregate supply (AD<AS) at full employment
output level (Antal and Van den, 2013). Equilibrium national income level is determined when
aggregate demand becomes equivalent to aggregate supply. However, full employment
equilibrium in the economy occurs when the AD and AS are equal and all resources are
employed fully.
b) i) If a large proportion of peoples incomes is saved , then the comsumers spending
automatically decreases. In addition, changes in interest rate implemented by the central bank of

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the respective countries influences the consumer’s expenditure habits. This affects the economic
growth of the nation as consumers expenditure makes up near about 70% of the nation.
However, if the purchasers stops spending , then the it adversely affects the national income of
the country. The overall productivity reduces and this impacts on the GDP growth of the
economy.
ii) Australia has been considered as the open economy and hence variation in GDP growth rate
occurs due to volumes of export as well as import of goods. if the exports increases and import
decreases, net export increases (Arena. and Quéré, 2016). As a result, share of consumer
expenditure decreases while expenditure share on purchases of government increases. As a
result, consumers spending in Australia reduces as exports increases.
Conclusion
From the above assignment, it can be concluded that behavior of both the consumer as well as
producer changes depending on the market structure. Implementation of government policy helps
in controlling the market in case of market failure. The nations circular flow diagram aids in
depicting the income flow on the country. In addition, increase in consumer income and rise in
exports also effects on the overall expenditure.

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References
Antal, M., & Van den Bergh, J. C. (2013). Macroeconomics, financial crisis and the
environment: Strategies for a sustainability transition. Environmental Innovation and
Societal Transitions, 6, 47-66.
Arena, R., & Quéré, M. (Eds.). (2016). The economics of Alfred Marshall: revisiting Marshall's
legacy. Springer.
Bauer, M. J. R. (2014). Principles of microeconomics.
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage
Learning.
Friedman, L. S. (2017). The microeconomics of public policy analysis. Princeton University
Press.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Mankiw, N. G. (2014). Essentials of economics. Cengage learning.
Marshall, A. (2015). The early economic writings of Alfred Marshall, 1867–1890. Springer.
Murota, R. I., & Ono, Y. (2015). Fiscal policy under deflationary gap and long-run stagnation:
Reinterpretation of Keynesian multipliers. Economic Modelling, 51, 596-603.
Reisman, D. (2013). The Economics of Alfred Marshall (Routledge Revivals). Routledge.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and
policies. McGraw-Hill.

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Sloman, J., Norris, K., & Garrett, D. (2013). Principles of economics. Pearson Higher Education
AU.
Taussig, F. W. (2013). Principles of economics (Vol. 2). Cosimo, Inc..
Tinkler, S., & Woods, J. (2013). The readability of principles of macroeconomics textbooks. The
Journal of Economic Education, 44(2), 178-191.