The Circular Flow of Income

https://www.tutor2u.net/economics/reference/circular-flow-of-income-and
-spending

Four Sector
Circular Flow of Income
Key Ideas about the Circular Flow Model
Source: https://www.intelligenteconomist.com/circular-flow-of-income/

The circular flow of income is illustrated in the circular-flow model

of the economy, which is one of the most significant basic models
within economics.
This model shows how different units in an economy interact,
breaking things down in a highly simplified manner. It shows how
household consumption is a firm’s income, which pays for labour
and other factors of production, and how those firms provide
households with income.
The circular flow of income demonstrates how economists
calculate national income, or gross domestic product (GDP).
 Key Terms for Circular Flow of
Income
 National Income  Saving
 National Output  Withdrawal (leakage)
 National Expenditure  Investment
 National Capital Stock  Injection
 Wealth  Open Economy
 Consumption
 Closed Economy
 Economic Agents in the Macroeconomy and Possible
Conflicting Objectives

HOUSEHOLDS FIRMS GOVERNMENT

Agent Objectives Conflict?
Consumers Lower prices; VFM; Firms pursuing profit;
Competitive markets Govt. regulation
Firms Profit; Expansion; Govt regulation, taxes;
Monopoly market Trade Unions
Government Society; Popularity More regulation for
households and firms
Workers Higher wages; job Firms maximising
CONSUMERS WORKERS security profit; Govt taxation
The Circular Flow of Income: 2 Sector
‘Closed’ Economy
The Circular Flow of Income: 4 Sector
‘Open’ Economy
INJECTIONS ADD INCOME
G = Government Expenditure
I = Investment
X = Exports

LEAKAGES REDUCE INCOME

The economy is in equilibrium, with no T = Taxation
tendency for GNP to rise or fall, when S = Savings
M = Imports
G+I+X=Y+S+M
Injections ↑ into and Leakages
↓ from the CFI
• Injections = G + I + X and Leakages = T + S + M
• If Injections > Leakages, GDP will rise (CP)
• If Leakages > Injections, GDP will fall (CP)
• If Leakages = Injections, GDP is in equilibrium
(CP) Equilibrium means ‘a state of rest’
How can you link
the CFI model to
a bath?!
The Circular Flow of Income: 4 Sector
Open Economy

National Income = GNP

 Circular Flow – Interactive
Model

https://ajmccarthynz.wordpress.com/2017/05/17/grappling-with-the-concepts-of-the-circular-flow-model/
Prep Task For Monday
• Review the slides above – some were used in class, but some are new! Note the link on
Slide 1 – have a look! https://
www.tutor2u.net/economics/reference/circular-flow-of-income-and-spending
 Study pages 160 – 166 in your Book 1 Textbook, making a note of all the key terms and
then have a go at the worksheet attached on SMHW.
 Answer these additional questions:
• What is the difference between GDP and GNP and why is this relevant to the Circular Flow of
Income?
• Using the Circular Flow concept, explain why: National
Income ≡ National Output ≡ National Expenditure
 Ensure your Schedule A Workbook is up to date, up to and including page 5
 Be prepared for a short answer test on all concepts covered so far on Tuesday 17th (next
week)