Chapter EMA, Problem 1CYU

To determine

To draw the circular flow diagram and label the maturity transformation area with its explanation.

Explanation of Solution

The following graph represents the circular-flow diagram including households, firms, and government:

  

The money received by households from the factor market will be used by households for consumption and savings. Households pay taxes and save the remaining money in the financial markets from where government and firms borrow.

The financial market such as banks and credit companies receive savings as their liability for the shorter period and pay a lower rate of interest to the savers while giving these savings as loans to the government and firms at a higher interest rate for the longer period.

This transaction of money from short-term savings to long terms loans is considered a mature transformation in an economy.

Government receives money in the forms of taxes and borrowings from the banks and spends those in the goods and services market. Investors borrow those savings from the bank as loans and invest in their businesses to generate money and pay the households and government.

Finally, these transactions generate GDP in the economy and money keeps rotating in the market among consumers, producers, the government, and the banks.

Economics Concept Introduction

The circular-flow diagram represents the flow of money and the transactions of goods and services between firms and households. These transactions happen in the market for goods and services and factor markets with the help of the financial market.