Republic of the Philippines

Laguna State Polytechnic University

Province of Laguna

Social Studies 8
Macroeconomics

THE CIRCULAR FLOW OF

ECONOMIC ACTIVITIES

BSED 2C
MRS. MARITES D. CARLOS
SECOND SEMESTER
A.Y. 2023-2024
 INJECTION AND LEAKAGES
Are terms commonly used in macroeconomics to describe the flow of money
into and out of an economy. These concepts are crucial for understanding how the
economy functions and the factors that influence its overall level of activity.

Injections: Injections refer to the addition of spending into the circular flow of income
within an economy. There are three main types of injections:

a. Investment: Investment refers to the spending by firms on capital goods such as

machinery, equipment, and buildings. This spending adds to the productive capacity
of the economy and stimulates economic activity.

b. Government spending: Government spending includes expenditures on goods

and services, as well as transfer payments such as welfare benefits and pensions.
Government spending injects money into the economy and can stimulate demand for
goods and services.

c. Exports: Exports are goods and services produced domestically and sold to
foreign countries. Export revenues represent an injection of income into the domestic
economy, increasing the total demand for goods and services.

Leakages: Leakages, on the other hand, refer to the withdrawal of money from the
circular flow of income. There are three main types of leakages:

a. Savings: Savings occur when households, businesses, or the government set

aside a portion of their income rather than spending it on consumption or investment.
Savings represent money that is not immediately circulating in the economy.

b. Taxes: Taxes are compulsory payments imposed by the government on

individuals and businesses. When taxes are levied, they reduce the disposable
income available for consumption and investment, leading to a leakage from the
circular flow of income.
c. Imports: Imports are goods and services produced in foreign countries and
purchased domestically. When money is spent on imports, it flows out of the
domestic economy, representing a leakage of spending.

In a simplified model of the economy, injections and leakages should ideally balance
each other out for economic equilibrium to be achieved. If injections exceed
leakages, there will be an increase in economic activity and output, leading to
economic growth. Conversely, if leakages exceed injections, there will be a decrease
in economic activity and output, potentially leading to economic contraction or
recession. Understanding the dynamics of injections and leakages helps
policymakers formulate appropriate fiscal and monetary policies to stabilize and
stimulate the economy.

THE MULTIPLIER EFFECT

The multiplier effect in economics refers to the idea that an initial change in spending
or investment can lead to a larger and more widespread economic impact. This
effect occurs because the initial spending sets off a chain reaction of increased
economic activity as the money circulates through the economy. Here's a simplified
example to illustrate the multiplier effect:

Let's say the government decides to invest $100 million in building a new highway.
The construction workers, engineers, and suppliers involved in the project receive
payments for their services. Now, these individuals, in turn, spend their earnings on
goods and services in the broader economy. This, in essence, injects money into
other sectors.

The multiplier effect is a concept in economics that describes how an initial change
in spending or investment can lead to a larger and more widespread impact on the
overall economy. It is based on the idea that when money is injected into the
economy, it doesn't just have a one-time impact; rather, it sets off a chain reaction of
increased economic activity. This occurs as the initial injection of spending circulates
through the economy, creating a ripple effect.
The multiplier effect is often associated with Keynesian economics, named after the
economist John Maynard Keynes. Keynes argued that during economic downturns,
when there is insufficient demand, the government can stimulate economic activity
by increasing its spending. The multiplier effect helps explain why the total impact on
the economy is greater than the initial government expenditure.

TYPES OF MULTIPLIER EFFECT

1. Income Multiplier: This is the most common type of multiplier. It measures the
change in overall income resulting from a change in spending. When individuals
or businesses spend money, the recipients of that spending then have more
income, leading to further spending and so on. The formula for the income
multiplier is 1/(1-MPC), where MPC is the marginal propensity to consume.

2. Government Spending Multiplier: This multiplier focuses on the impact of

changes in government spending. When the government increases its spending,
it can lead to a chain reaction of increased consumption and production
throughout the economy. The government spending multiplier is influenced by the
marginal propensity to consume and the marginal tax rate.

3. Investment Multiplier: Similar to the government spending multiplier, the

investment multiplier measures the impact of changes in private sector
investment. When businesses invest in new projects or capital, it can lead to
increased income and spending in the economy. The investment multiplier is
influenced by the marginal propensity to consume.

4. Tax Multiplier: This multiplier explores the impact of changes in taxes on the
economy. When taxes are cut, individuals and businesses have more disposable
income, which can lead to increased spending. The tax multiplier is influenced by
the marginal propensity to consume.

5. Export Multiplier: This multiplier considers the impact of changes in exports on

the economy. When a country's exports increase, it can lead to increased
 production and income. The export multiplier is influenced by the marginal
propensity to consume and the import coefficient.

6. Financial Multiplier: This multiplier focuses on the impact of changes in the

money supply on the overall economy. An initial injection of money into the
economy can lead to increased spending, which, in turn, stimulates further
economic activity.

Here's a simplified explanation of the circular flow of the multiplier effect:

 Initial Increase in Spending (Injection): The process begins with an initial

increase in spending, often in the form of government spending, investment, or
exports. This injection of money into the economy creates new income for
businesses and individuals.

 Increased Income for Recipients: The recipients of the initial spending, such as
workers or suppliers, experience an increase in income. This leads to higher
disposable income for these individuals and businesses.

 Rise in Consumer Spending (Consumption): With higher disposable income,

individuals and households tend to increase their consumption spending. This, in
turn, boosts the revenue of businesses that sell goods and services to
consumers.

 Business Revenue and Employment: As consumer spending rises, businesses

experience an increase in revenue. To meet the growing demand for goods and
services, businesses may need to expand production, leading to higher
employment levels.

 Further Rounds of Spending: The cycle continues as the newly employed

individuals and businesses, in turn, spend their income on goods and services.
 This creates additional rounds of spending, with each round contributing to an
increase in overall economic activity.

 Multiplier Effect: The multiplier effect refers to the cumulative impact of each
round of spending. The total increase in economic output is greater than the initial
injection of spending. The multiplier effect is often represented by a multiplier
coefficient, which indicates the ratio of the overall change in income to the initial
change in spending.

 Leakages (Savings and Taxes): The multiplier process can be affected by

leakages, such as savings and taxes. When individuals save a portion of their
income or when taxes are levied on income, it reduces the amount of money
circulating in the economy and, consequently, the overall impact of the multiplier.

 Equilibrium: The circular flow of the multiplier effect continues until leakages
balance with injections. In an ideal scenario, the economy reaches equilibrium
with a higher level of income and output compared to the initial injection of
spending.

Understanding the circular flow of the multiplier effect is essential for policymakers
and economists to assess the potential impact of economic stimuli and changes in
spending patterns on overall economic activity.

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effect/#:~:text=This%20is%20called%20the%20multiplier,the%20initial%20dollar
%20amount%20spent .
https://uk.indeed.com/career-advice/career-development/what-is-a-multiplier