A closed economy is one which is self-contained and self-sufficient so that it has no economic dealings with the outside world. In a closed economy the accounts may be prepared on a uniform basis and classified as (i) transactions relating to productive activity (ii) transaction relating to the use of gain from productive activity (iii) transactions relating to capital. By consolidating these accounts prepared for each firm, house hold, government agencies and every other transactor, we get three consolidated national accounts (a) Production (or operating) Account (b) Consumption (or appropriation) Account (c) Accumulation (or capital transaction) Account. Let us explain there three accounts.
In this account we include all productive activities being carried on in the entire economy. It is a consolidated production statement relating to all firms operating in the economy. These firms manufacture commodities meant for consumption and capital goods and equipment for generating accumulating wealth. The income obtained by these firms therefore comes through two channels viz partly by selling consumption goods and partly be selling capital equipments. The flow of this revenue is indicated by the direction of the arrows.
In these accounts purchases and sells by the firms from one another have obviously to be left out. They may be important for individual accounts but in the national or social accounts they cancel out.
In the above diagram, all proceeds of the sales of production are shown as being paid out as income to the factors of production i.e. to those who have taken part in the process of production. These payments take the form of wages to labour, salaries to the employees interest on capital, rent the land lord i.e. the owners of land and business premises and profit going to the entrepreneur. The incomes are shown in the diagram as flowing from production its consumption by an arrow.
The incomes received by the factors production may be either spent on consumption i.e. for the satisfaction of their immediate wants or they may be party saved. The income spent on commodities is shown by an arrow going towards production from consumption and the part which is saved is shown by the arrow going from consumption to accumulation. Transactions of the consumers among themselves paying cash to one another are ignored just as we ignored the buying and selling activities of the producers among themselves.
We have seen that whole of the sale proceeds of production go into consumption and consumption income is divided into spending and saving. It follows therefore that saving is equal to capital expenditure on real assets or investments. Thus we get following two equations
Y = C + S -------------(1)
S = I -------------------(2)
Here Y stands for income paid to the factors of production, C stands for consumers expenditure on commodities and services and S is saving (for income not consumed) I is investment (or capital expenditure on real assets) If we substitute for S from equation (2) into equation (1) we get the following equation.
Y = C + I ---------------(3)
There relationships pertain to simple closed economy which has no trading or financial relations with rest of the world.
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