Where does investment originate from in the circular flow model? The above image is from my macroeconomics textbook.
I’m struggling to understand the “financial markets” corner. If financial markets refers to banking and perhaps the stock market, is it true that its only input is savings from households? Don’t firms also participate?
And if investment refers strictly to capital goods and additions to inventory, then shouldn’t the I arrow originate from firms, who make the investments?
If everything that a firm makes becomes income, then where does it get money for investment? It seems from the diagram that all of the firm’s profit goes straight to the resource market—paying employees, etc.
(On a more basic level, how does wealth ever actually increase/the economy ever grow if everything is a cycle? I understand that a central bank could do things in the financial market to increase money supply, but assuming such a system as a gold standard, is it even possible for the economy to grow?)
I appreciate your answers.
Investment ultimately comes from households through savings. From a macroeconomic perspective savings is equal to to investment ($S=I$).
Investment comes from income because saving is portion of income that is not consumed. For example, if your income is $\\\$1000$ and you consume $\\\$700$ of it the $\\\$300$ you are left it is by definition saving and saving is ultimately equal to investment.
For example, when you put $\\\$300$ into your bank account you are actually inserting it into financial sector and bank will actually use the money on your deposit account to finance loans for investment even if you might not know about it.
This is why the arrows are as they are. Households supply saving to financial markets where firms who need money to make investments get it from.
The economy grows because even though everything is a circle the income increases each year as economy becomes more productive thanks to improvements in technology. For example, if today you can make 100 widgets then your income will be equal to the value of those 100 widgets. If thanks to increase in technology you can produce 200 widgets your new income is equal to the value of those 200 widgets.