circular flow of income

circular flow of income

shows how money, goods, and services move between different sectors of the economy. It explains how national income is generated and spent.

injections

government spending

investments

exports

withdrawals

taxes

savings

imports

National income is in equilibrium when:

Injections = Withdrawals

If injections > withdrawals

economy grows (boom).

output is grater than expenditure

firms reduce output

national output, income + expenditure decreases

savings = investment

If withdrawals > injections

economy contracts (recession)

expenditure is greater than output firm increase output

national output, income, expenditure increase

multiplier effect

an injection is made and the actual change in income is greater than the initial injection

change in output/change in injection

shows by how much the GDP has increased

formula for multiplier effect

Multiplier= 1/1-MPC = 1​/MPW

MPC = marginal propensity to consume

MPW = marginal propensity

how much extra does a consumer purchase when they receive one extra pound of income

Importance of circular flow model in Economics

Shows how national income is determined.

Explains the link between output, income, and expenditure.

Foundation for understanding national accounts (GDP, GNI, etc.).

Helps explain how shocks (e.g., investment fall, tax rises) affect the economy.