The video Circular flow of income and expenditures | Macroeconomics | Khan Academy explains the principles of the described circular flow of income and expenses quite well. In particular, it focuses on how exactly the process of circular interaction between the two elements in a financial system occurs (Khan Academy, 2012). When describing this circular mechanism, it is worth noting that although the character in the video is fictional, this principle is quite illustrative.
It is based on the mechanism of renting something to provide services to a particular business, for which this firm can make a profit, some part of which it pays to the owner of the rented object. In addition to that, the company also pays for the use of other people’s property and the lessor’s labor. He, in turn, spends a certain amount of money for the services provided by this, or not only this particular company. Thus, the landlord pays a sum which, in the end, can go to the company which is engaged in renting from this person. This creates a mechanism of circular circulation of money, where finances are circularly distributed between the parties to the agreement. The video shows that the amount spent on rent and payment for services is approximately the same.
However, this is only theoretical because, in reality, there are taxes that deduct part of this amount and do not make it equal to the amount paid by the landlord. It is also worth it because the company’s profitability depends on additional payments to the landlord of the rental space or production equipment. Thus, the government and international trade intervene in this mechanism, which receives a certain percentage at the expense of taxes or payments for the transportation of goods or the exchange of money.
A direct relationship between two or more constituents involves interaction without intermediary forces. It is worth noting that these variables affect each other in an increasingly dynamic, while the inverse relationship implies a declining trend. These direct relationships can be expressed through the formula a=bk, where k is the variable’s coefficient. Looking at the above formula, as the coefficient grows, both b and a grow, which is an explicit confirmation of the theory mentioned above. Whereas the inverse ratio formula is expressed as a = b/k, where k is the coefficient. An example of such relations is the formula for the distance traveled, where distance is the speed of movement multiplied by time. In contrast, the formula for dividing the distance by the time it took to cover it is more appropriate for inverse relations.
The slope of a line formula can be expressed as m = Δy/Δx, where m is the slope. It demonstrates a continuous rise or fall, directly proportional to the step traveled. It is most often used in the above example of calculating the distance traveled since the data there are static. Financially, it also has a place because depending on the money spent by a user, the company’s profit grows, and vice versa. The term ceteris paribus also applies to this formula because it denotes the point where two variables are equal and converge to one point on the coordinate system. This is possible if one of the variables is zero or infinity. Based on the relationship between the variables, a graph can be plotted to demonstrate their relationship.
Reference
Khan Academy. (2012).Circular flow of income and expenditures | Macroeconomics | Khan Academy.