How Important Is Flow Of Money For The Economy?

Definition of "How important is flow of money for the economy?"

Liz  Dawes real estate agent

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Liz Daweselite badge icon

eXp Realty, LLC- Dawes Team

Many consider the appearance of money as the source of all evils in society. This is a rather one-sided approach, while the bigger picture is more complex. 

An economy based on barter vs. money

As opposed to a barter-based economy, money created a common medium of exchange. Additionally, it works on the principle of money-supply centralization and currency stability. A central bank (in our case, the Federal Reserve) or government plays an important role, so everyone accepts its universal value on a given territory.

Let’s find out how macroeconomics, or studying a country’s economy, works!

Which are an economy’s fundamental components?

An economy’s key components are companies, households, and governments. Firms provide homes with services and goods. In exchange, companies require certain household production items, such as land, money or capital,  labor, or even entrepreneurship. 

Since everything has a price tag, every economic player charges a specific fee for their input. Our hard work or real estate doesn’t come for free. As a result, a circular flow of money ensues. In other words, capital circulates in opposite directions. Firstly, homes will pay for the items they get from companies. Secondly, companies will pay households for their labor through salaries, rents, profits, or interests. 

The flow of money influences investments

Individuals and families don’t spend everything they earn. They also put savings aside. Ideally, we don’t keep our nest egg under the pillow. Instead, we deposit it in banks to keep it safe and to earn interest payments. This process can be an excellent and smart investment even during a recession

On the other side, banks lend our money to companies. Firms also need capital to purchase equipment and pay for their production. Thus, you can see the significance of investments permeating the economy through money. 

Government's role

Governments also purchase goods and services. This means income for households and firms, and money flows out of the economy. 

A nation’s governing body receives money through taxes, so capital flows out of the company and home budgets. Thus, taxes are the primary source of government spending.  

International trade

Countries and states interact with one another through trade. For instance, the United States imports items from various countries. Money spent on imports flows out of America’s budget. However, the US can levy taxes on imports to reduce expenditures.

The States will export goods as well. In this case, money flows in the US from foreign countries. We call this American export earning. Government expenses, export earnings, and investments are the so-called injections because money flows in. On the other hand, we label taxes, savings, and import spending as withdrawals since cash flows out of the system.

Exports and imports set the tone for money flow in the US.

Savings often lead to investments. Here are the top three types of investments: real estate, gold, and stock market bonds. The United States makes considerable money from foreign investors’ economic input by exporting goods and services. 

Did you know that the top three American exports (as of 2022) were: gasoline and other fuels, natural gases, and civilian aircraft parts? The US revenue after fuels achieved 114 billion Dollars last year. The major importing countries were Canada, Mexico, and Chile.

Another essential capital influx comes from foreign investments in US territory. No wonder many see a huge potential in selling properties to foreigners

We measure the size of a country’s economy in the gross domestic product (GDP.) GDP is the total value of final goods and services mass-produced in a country.

The flow of money leads to various benefits. 

The three most notable perks of money flow are the following.

  • First, the money flow established a crucial connection between consumers and producers. 
  • Secondly, it facilitates the emergence of a series of complex market networks. 
  • Thirdly, the money supply regulates the economy. 

Suppose consumption expenses and investment get high in a society, or injections in the flow of money are substantial. In that case, it increases income, employment, and prices, which ultimately can lead to inflation. Then, the FED can address inflation by reducing the money supply.

Conclusion

Undoubtedly, the crucial advantage of money over the barter system as a paying medium is that it’s universally adopted. The natural flow of money in an economy makes a society thrive. Besides, it facilitates technological, individual, and national progress in every imaginable way.

One thing is sure; countries facing ecological hardships strive to devise a circular economy to create a sustainable future.

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