The movement of spending and

income throughout the economy

 Explain the Circular Flow of Income.

 Recallhow leakages and injections affect

the circular flow.

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 The Circular Flow Of Income

Households

Spending

Factor Incomes Products Factor Services

Firms

Factor Incomes Factor Services

Wages/Salaries Labour
Interest Capital
Profit Entrepreneur 3
Rent Land
 • Not all FACTOR INCOME is spent on goods.
There are leakages from income. What do you think
these are?:
• Taxation - taken from wages and off the price of
goods (VAT) etc
• Savings – households may not spend all their
income
• Imports – households and firms may spend on
imports.

ALL OF THE ABOVE ARE LEAKAGES FROM INCOME

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 The Circular Flow Of Income

Tax
Savings
Imports

Households

Spending

Factor Incomes Products Factor Services

Firms

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These LEAKAGES reduce the circular flow of income WHY ?

They represent money leaving Income :

 Taxation goes to government.
 Savings are put into bank accounts.
 Import spending goes abroad.

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 INJECTIONS
In contrast, there are 3 forms of spending that are injected into
the flow.
Injection: Additions of extra spending into the circular flow of
income
These are ;
• Government Spending
• Investment
• Exports
What are each of the above?
• Government spending is money spent by the government on
NHS, defence, benefits, education etc.
• Investment is money spent by firms on capital goods.

• Exports are goods sold by firms abroad

Injections come from outside of the circular flow.

They increase the circular flow. 7
 The Circular Flow Of Income
Savings
Imports
Tax

Households

Spending

Factor Incomes Products Factor Services

Firms
Investment
Exports
Government
Spending 8
WHAT DO INJECTIONS AND LEAKAGES DO TO THE CIRCULAR
FLOW OF INCOME?

If Injections > Leakages then…. ?

Income Rises

If Leakages > Injections then…. ?

Income Falls

If Injections = Leakages then…. ?

Income Stays the Same

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1. What is the circular flow of income?

2. What is an injection?

3. What is a leakage?

4. What are the 3 leakages and 3

injections?

5. Draw it.
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11
 Circular Income Flow in a Two Sector
Economy:

Real flows of resources, goods and services have

been shown in Figure.
In the upper loop of this figure, the resources
such as land, capital and entrepreneurial ability
flow from households to business firms as
indicated by the arrow mark.
In opposite direction to this, money flows from
business firms to the households as factor
payments such as wages, rent, interest and
profits.

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13
 Circular Income Flow in a Three Sector
Economy:

In our above analysis of money flow, we have

ignored the existence of government for the
sake of making our circular flow model simple.

This is quite unrealistic because government

absorbs a good part of the incomes earned by
households. Government affects the economy
in a number of ways.

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 Circular Income Flow in a Three Sector Economy:

Here we will concentrate on its taxing, spending and

borrowing roles. Government purchases goods and
services just as households and firms do. Government
expenditure takes many forms including spending on
capital goods and infrastructure (highways, power,
communication), on defence goods, and on education and
public health and so on.

These add to the money flows which are shown in Figure,

where a box representing Government has been drawn. It
will be seen that government purchases of goods and
services from firms and households are shown as flow of
money spending on goods and services.
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16
 Money Income Flows in the Four Sector Open
Economy: Adding Foreign Sector:

We now turn to explain the money flows that are

generated in an open economy, that is, economy which
have trade relations with foreign countries. Thus, the
inclusion of the foreign sector will reveal to us the
interaction of the domestic economy with foreign
countries.
Foreigners interact with the domestic firms and
households through exports and imports of goods and
services as well as through borrowing and lending
operations through financial market. Goods and
services produced within the domestic territory which
are sold to the foreigners are called exports.

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Money Income Flows in the Four Sector Open
Economy: Adding Foreign Sector:

On the other hand, purchases of foreign-made

goods and services by domestic households
are called imports. Figure illustrates additional
money flows that occur in the open economy
when exports and imports also exist in the
economy.

In our analysis, we assume it is only the business

firms of the domestic economy that interact
with foreign countries and therefore export and
import goods and services.
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