2.4.1 National Income (Macro)

WHAT IS THE CIRCULAR FLOW OF INCOME MODEL

The circular flow of income is a fundamental concept in economics that illustrates how money and goods/services circulate within an economy between households, businesses, and the government.

This model shows the interconnections between different economic agents and highlights the flow of income and expenditure.

(G) GOVERNMENT SECTOR- injection

It collects taxes from households and businesses, provides public goods and services (like infrastructure, defence, health, transport and education), and may also redistribute income through various welfare programmes.

Increase in government spending → firms earn more → employ more workers → incomes rise → further consumption.

Injects demand through investing it into social services.

(I) INVESTMENT - injection

Firms investing financial capital to boost their financial assets, in order to make more goods and services. They use this revenue to pay for factors of production in (e.g., wages to employees, rent for land).

They hire labour, use capital and natural resources, and sell the products they make to households.

Firms receive revenue from the sale of goods and services

(X) EXPORTS - injection

Injects money back into the economy via profit from trading goods and services to other countries.

(extra injection) HOUSEHOLDS

Households are the individuals and families within the economy. Households receive income from the factors of production they provide to firms (e.g., wages for labour, rent for land, interest for capital).

This income is then spent by households on goods and services in the product market.

(M) IMPORTS - withdrawal

Withdrawal from our circular flow, as we are moving money out of the economy and spending it on goods and services from other countries. In the UK we have a trade surplus in services, but a trade deficit in goods.

(T) TAXATION - withdrawal

This shows income taken out of the circular flow by the government through taxation (e.g. income tax, VAT), reducing households’ spending power.

(S) SAVINGS - withdrawal

Money leaked out of the circular flow due to households saving a part of their income instead of spending it on goods and services, preventing money being injected back into the economy.

INCOME

Refers to money and individual earns through work investments or other sources regularly over a specific period of time, typically on a recurring basis, such as monthly or annually.

WEALTH

Refers to the total value of a persons individual assests or household assets, minus their debts. Its a measure of net worth, not just income.

INJECTIONS AND LEAKAGES FROM THE CIRCULAR FLOW

• When injections are greater than withdrawals the amount of money in the circular flow increases, representing economic growth.

• When injections are less than withdrawals the amount of money in the circular flow decreases, representing a fall in real GDP.

MULTIPLIER EFFECT

Occurs when the change in AD is greater then the initial injection that brought it about.

Happens when there is a change in the initial spending, leading to a larger and more widespread final impact on the economies total output and income.

Ex Q: Evaluate the view that an increase in injections will always increase national income. (15 marks)

Introduction (AO1)

• Define injections: additions to the circular flow (Investment, Government spending, Exports).

• Define national income.

• State link: In the circular flow model, if injections > leakages → national income rises.

• Judgement line: However, this may not always happen depending on leakages and the multiplier

Paragraph 1 – Why injections increase national income (AO1 + AO2)

Point: An increase in injections should increase national income.

• Explain multiplier process.

• Extra spending → higher income → further spending.

• Use multiplier formula

• Example: Increase in government spending → firms earn more → employ more workers → incomes rise → further consumption.

Mini-evaluation within paragraph:
Effect depends on size of MPC.

Paragraph 2 – Role of leakages (AO2 + AO3)

Point: National income may not rise significantly if leakages are high.

• Leakages = savings, taxation, imports.

• Explain effects of the MPS, MPT and MPI, and how it effect multiplier effect (limits the injections effect)

• If people save more, less is re-spent → multiplier weakens.

• Tax more, less disposable income to spend on goods and services, so less money injected, weakens multiplier.

• High imports → money leaves domestic economy.

• Therefore injections may “leak out”.

Evaluation:
In open economies with high imports, the multiplier may be small.

Paragraph 3 – Capacity constraints (AO3)

Point: Injections may not increase real national income if the economy is near full capacity.

• If economy is at/near full employment → mainly inflationary.

• AD increases → price level rises rather than real output.

Evaluation:
Stronger impact during recession than during boom.

Conclusion (AO3 Judgement)

• In theory, injections increase national income.

• In practice, the effect depends on:

  • Size of leakages

  • Size of multiplier

  • State of the economy (spare capacity)

• Final judgement: Injections are likely to increase national income, but not always significantly or in real terms.