Importance of circular Flow in Open Economy

Importance of Circular Flow in an Open Economy Following points show the importance of circular flow in an open economy : 

1. Importance of National Income Accounting: The national income accounting is based on the statistics of receipts and payments of the different sectors namely, business, household and government. The same conclusions can be derived in a more simple and attractive manner through the circular flows of national product, income and expenditure. 

2. Knowledge of the Functioning of the Economy: 

The circular flows of income spent and of product provides a complete knowledge about the functioning of the economy. 

3. Effects of Injections and Leakages upon Economic Activity : 

The increase in investment, exports etc. in the circular flow signifies injections. On the other hand, savings, imports etc. are considered as leakages. If injections are less as compared to the leakages, then it is harmful for an open economy but if injections are more than the leakages, there is an expansion in economicactivity. 

4. Importance of Money Cycles : 

If the injections are more than Importance of Circular Flow in an Open Economy Following points show the importance of circular flow in an open economy : 

5. Importance of Monetary Policy : 

The central bank will employ the policy of expanding money and credit during deflation or depression. On the contrary, the central bank will reduce the quantity of money and credit in the condition of boom or inflation. 

6. Importance of Fiscal Policy : 

If there is a state of depression or unemployment, in order to make injection more powerful than the leakages, the government relies upon the fiscal measures like increase in government spending, reduction in taxes, deficit financing etc. On the opposite hand, the government brings about reduction in injections relative to leakages in the times of boom or inflation through such policy measures as reduction in public spending, increase in taxes and surplus budget.