The circular flow model with government sector impacts the circulation of money through taxes, transfers and government purchases. The households provide labor and ready market for goods and services produced and sold in an economy. Through labor, the households receive an income, which is referred to as national income. Almost 40% of the national income goes to the government as taxes and therefore, not available for spending (Colander, 2002). Taxes collected by the government go back to some households as transfers.
Transfers can be saved or spent by the households that receive it. In any economy, the largest transfers normally go to the social security funds. Income from active taxpayers is transferred to retired or disabled citizens. Some amounts of transfers together with remaining amounts after taxes add up to disposable incomes for the households. Disposable income equals national income minus taxes plus transfers in the economy. Households can decide to save part of the incomes in the financial institutions who in turn lend money to businesses in need of money to fund their transactions (Colander, 2002). Disposable income also allows businesses to consume products offered for sale by businesses.
Production possibilities model can be demonstrated either using a table or a graph. This model attempts to provide results given a variety of combination in resources available against time allocated for a project. Production possibilities curve show that every choice an individual makes has an opportunity cost. The curve summarize that one can get more of a given item if they give up something else. According to this model, given the existing resources, there is a limit of what an individual can achieve in life. This model, according to Colander (2002), can play a vital role in the economy, especially when firms need to achieve production efficiency.
International relations fit into the circular flow diagram from the business sector. A single economy cannot produce all the goods and services thus there is a need to import goods and services. On the other hand, exports must be made so that surplus products can be rid off the stores and attract more taxes to the government (Colander, 2002).
Microeconomics is a division concerned with the study of individual households and firms’ efficiency in allocating limited resources. Macroeconomics is a division that deals with studies into the total of all economic decisions that affect employment, inflation and growth.