circular flow of income 2.1 econs

circular flow of income definition

a model showing how income flows in an economy between different economic agents

injections definition

money flows into the economy , representing an inflow of income in an economy , more g/s purchased , higher output produced by firms

• include : investment , export , govt expenditure

leakages definition

representing an outflow of income from the economy, less g/s purchased , lower output produced by firms

• include imports, savings and taxes

injection and leakage pairing + diagram

leakage (S+T+M) —> saving , taxes ,imports(spending on foreign goods and services)

injections(I+G+X)—> investments (spending by firms on capital goods), government spending (governments expenditure), exports(spending by foreigns on domestic goods)

Injections= leakage meaning

• only at equilibrium

• no change in income entering the flow / unemployment rate / output produced

Injections > leakages meaning

1. more income enters the flow

2. more goods and services are purchased

3. incentive for firms to increase more output + buy more FOP

4. reducing unemployment

5. raising household income and output increases

6. economy grows

Injections<leakages meaning

1. more incomes flows out of the economy

2. lesser goods and services are purchased

3. lesser incentive for firms to increase output , hence lesser FOP bought

4. increasing unemployment

5. decreasing household income and output decrease

6. economy worsens

open economy definition

an economy that is engaged in international trade

closed economy definition

an economy that does not trade with other economies

2 sector economy,

• compromise of only household and firms , the financial sector

• leakage : savings only

• injection: investment only

3 sector economy

• compromise of household, firms , financial and government sector

• leakages : savings and taxations (reduce flow of income in the economy as lesser income is spent on goods and services , hence income leaks out of the economy)

• injections: investment and government expenditure (use tax revenue to improve social welfare, increasing flow of income into the economy)

4 sector economy (open economy)

• household , firms , financial sector, government sector , foreign sector

• leakages: savings , taxes, imports (money spent on foreign goods)

• injections : investments , government expenditure , exports (amount of money spent on domestic goods/foreigns buy domestic products )

real flow and income flow definition

real flow: how goods and services are produced and consumed in an economy

income flow: flow of income and expenditure

closed economy circular flow diagram

*only household and firms are the economic agents involved

• red + pink real flow the rest income flow

households definition

owners of labour, entrepreneurship, capital and land, purchase goods and services from firms and receive factor rewards

firms definition

buy the FOP that households produce, pay factor rewards, purchaser of FOPS

circular flow of income model with leakages and injections diagram flow)

Investment spending definition

Spending by firms on capital goods

investment is spent on

1. fixed capital —> machinery , buildings etc

2. increase in inventory —> increase in stocks of raw / intermediate / finished goods held by firms waiting to be sold

3. firms borrow funds from the bank to do so

savings

some households choose to save money in financial institutes like banks , reducing the flow of income in the economy as lesser money is spent on goods and services . income leaks out the economy

Consumption spending definition

Spending by households on goods and services

Government spendings definition

Government purchases of FOP for public investments

Export definition

Goods and services produced domestically , sold to other countries

Import definition

Goods and services produced abroad, buy from foreign countries

national income = national output = national expenditure , useful because

1. helps assess economy performance over time

2. measure standard of living

3. make comparisons of income or output performances with other economies

national output approach

total output of final goods and services produced within a country over a period of time

• value of final goods and services calculated by summing up value added

• excludes imports purchases but includes export earnings

value added definition

at each stage of the production process, costs of inputs are deducted , so as to not double count . Value of intermediate goods used in the production of final good not counted

• eg .

advantages of output approach

1. helps assess the effectiveness of govt efforts to promote growth

2. allow comparisons of performance across sectors and across countries

national income approach

total income earned by all resource owners in producing final goods and services within a country over a period of time

• basically adding up all factor income ( total income paid to all owners of resources )

income approach calculation

GDP= rent +wages +interest +profit

national expenditure approach + formula

total spending on final goods and services produced within a country over a time period

• Consumer expenditure + investment + govt spending +(export - import )