Circular Flow

Topics: Economics, Investment, Gross domestic product Pages: 3 (835 words) Published: February 12, 2012

The Circular Flow of Income, expenditure and output is a model of the economy which shows the movement of goods and services between households and firms and their corresponding payments in money terms Money circulates from households to firms and back again. The more a households spend and the more firms produce, the higher the levels of income. Income + output in economy should always be same and are measured by GDP. Circular Flow emphasizes importance of interactions of households, firms + other economic factors in macro-economy Households own all FoP (LLCE) Firms are producing units which hire services provided by the people from households Money moves from households to firms when they buy goods + services and money moves back to households as payment for using the factors of production through rent (land) , wages (labour), interest and profit/dividend (capital).

Leakages – (withdrawals) from circular flow income are S (savings), T (tax) and M (imports). Some income is saved and saving represents leakage from the circular flow of income because its part of the income paid out by firms which does not return to them through spending of households. If you save, economy slows down as there's less money in circular flow. So if Gov. takes money from economy in form of tax and doesn't spend it, or if people buy more things from abroad than they export (foreign trade), economy slows down as money leaves circular flow. Leakages determine size of multiplier. Tax is leakage because they remove purchasing power from the system.

Injection – in circular flow are I (investment – increase in capital stock), G (government spending) and X (exports) Export is injection as spending of foreign households on domestic produced output is an additional source of income. Increase in investment (machinery, building) may increase spending in an economy as well as productive capacity enabling economic growth. Firms contribute to expenditure when they...
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