Week 5: Problem 4

Week 5: Problem 4

Q1

1.1: Why must the Vertical Columns sum to zero?

The change in the amount of money held by the sector must equal the difference between receipts and the payments made by the different sectors, i.e. the households and the Government.

1.2: Why must the Horizontal Rows sum to zero?

Each component of the matrix must have an equivalent component elsewhere in the matrix, in line with the Circular Flow of Income theory.

Q2

2. Production: Cs and Gs both represent sources of revenues i.e. the income that is collected by the production sector. They represent the sales of consumption and government services in the economy. The sum of these two figures (i.e. total production – [Y]) defines the national income identity and appears in brackets as it doesn’t represent a transaction between sectors. The production sector then supplies the household sector and the government with services and demands a certain volume of employment (Nd) at a given wage rate (W). This figure appears as a negative here as it is seen as a cost for the sector.

3. Government: Here, Gd represents the purchase of government services and therefore appears as a negative figure as it represents a cash outflow. Taxes are levied by the government as some proportion of household and production income – Td. Td represents a source of revenue for the sector and therefore appears as a positive figure. Hs represents the change in the stock of money issued by the government. Hs is given by the difference between government receipts and outlays during the period. As the change in Hs (ΔHs) is said to be equal to Gd-Td, the column therefore sums to zero.