Circular flow of income

• Economic agents involved in economic activity:

  • Firms
  • Households
  • Government
• In an economy, economic agents interact and exchange resources:

  • Households → firms: purchase goods and services, provide demand
  • Households provide factors of production (labor and capital) and receive wages and dividends in return
  • Firms → households: provide wages, dividends, interest, profit, and receive income
  • Households → government: pay taxes
  • Firms → government: pay taxes
  • Government → households: provide social transfers (benefits)
  • Government → firms: make government purchases (subsidies and grants)
• Injections into the circular flow of income/economy:

  • Money entering the economy
  • Examples: Exports, Government spending, Investment
• Leakages from the circular flow of income/economy:

  • Money exiting the economy
  • Examples: Savings, Taxes, Imports
• If leakages equal injections, the economy is in equilibrium

  • If leakages exceed injections, there is a contraction of production leading to decreased output and expenditure
  • If injections exceed leakages, there is an expansion in national output leading to increased expenditure
• Methods to measure economic activity:

  • National income = national output = national expenditure
  • Total income = total output = total expenditure
  • Calculated through value added, sum of incomes, and expenditure
• Types of flows in the economy:

  • Physical flow: flow of goods or services (e.g., electricity)
  • Monetary flow: flow of money (e.g., taxes, consumption)