Circular Flow: Injections & Leakages

What is the Circular Flow?

• The circular flow of income and spending shows connections between sectors of an economy.

• It illustrates the flow of:

  • Goods & services

  • Factors of production (land, labour, capital, enterprise)

• Demonstrates how national income / GDP is calculated.

• Businesses produce goods & services → generate income for factors of production (e.g., wages, salaries).

Leakages (Withdrawals)

• Not all household income flows directly to businesses.

• Three main leakages:

  1. Savings (S): income set aside for future spending (e.g., bank deposits).

  2. Taxation (T): income paid to the government (e.g., income tax, national insurance).

  3. Imports (M): spending on foreign-made goods/services.

• Effect of withdrawals:

  • Increase in savings, taxes, or imports → reduces circular flow of income.

  • Leads to a multiplied contraction in production (output).

Injections

• Additions into the circular flow that boost income and output.

• Three main injections:

  1. Investment (I): capital spending by firms (e.g., new technology, machinery).

  2. Government Spending (G): expenditure on services (e.g., defence, healthcare).

  3. Exports (X): overseas consumers buying domestic goods/services.

• Effect of injections:

  • Increase in investment, government spending, or exports → raises income.

  • Leads to a multiplied expansion in output.

Equilibrium in the Circular Flow

• An economy is in equilibrium when:

  • Injections = Withdrawals

  • (I + G + X) = (S + T + M)