The Cash Flow System

The circular flow of income involves two basic principles. The first principle says that in any exchange process, the seller or producer receives the same amount as the buyer or consumer spends. The second principle states that goods and services flow in one direction and money payment to get these goods and services flow in a return direction, causing a circular flow. (Absolute Astronomy, n.d.) This circular flow is made up of two systems, a closed system and an open system.

As defined by the Editorial Board, “a closed system is an economic model that counts only domestic exchanges but not foreign agents.” (Macroeconomics, 2011) It is a system where the economy is without international trade. Businesses and industries are owned by the government in closed systems. In this system money is spent solely within the economy, making it completely self-sufficient. It is an attempt to meet all consumer needs by internally producing all purchases and sales of goods and services. In a closed economy all individual income is sent back to employers when goods and services are purchased, and back to employees through wages and dividends. An example of a country with a closed system is North Korea.

An open economy is defined as “an economic model that counts the goods and services exchanged domestically and between nations. (Macroeconomics, 2011) It’s an economy with international trade. In an open economy, the majority of the goods and services produced are exported to customers around the world, while also encouraging the importing of goods or services that cannot be produced internally at competitive

prices. (Investopedia, n.d.) Examples of countries with open systems are the United States and the United Kingdom.

Leakages and injections are both needed for circular flow. Leakages are situations in which income leaves an economy, instead of staying in it. Leakage occurs when