2.4

• injections

  adding income to the circular flow of income

  • investment
  • government spending
  • exports
• withdrawals

  contract the circular flow of income

  • saving
  • taxation
  • imports
• simple multiplier

  1/MPS

  1/1-MPC
• Circular flow of income

  • Describes the flow of money and resources between households, businesses, and the government
• Basic Model of the Circular Flow of Income

  1. Households supply factors of production to firms

  2. Firms produce goods and services sold to households

  3. Households use income to purchase goods and services from firms
• Injections and Withdrawals

  • Injections are additions to the circular flow of income
  • Withdrawals are subtractions from the circular flow of income
• Injections

  • Investment
  • Government spending
  • Exports
• Withdrawals

  • Savings
  • Taxes
  • Imports
• Government's role in the circular flow of income

  Can increase or decrease injections and withdrawals to stabilize the economy
• During a recession, the government may increase government spending or reduce taxes to stimulate economic growth
• During times of inflation, the government may increase taxes or reduce government spending to slow down the economy
• Difference between income and wealth

  • Income is a flow concept, wealth is a stock concept
• Income as a Flow Concept

  Amount of money or value received in exchange for labour or capital over a specific period
• Examples of Income

  • Monthly salary
  • Annual bonus
  • Rental income from properties
  • Interest received on a savings account
  • Dividends received from owning shares in a company
• Wealth as a Stock Concept

  Total value of assets owned minus liabilities at a given point in time
• Examples of Wealth

  • A house or property owned
  • Investments in stocks, bonds, or mutual funds
  • Cash in savings or investment accounts
  • Valuable possessions such as jewelry, cars, or artwork
• Relationship between Income and Wealth

  Income can help increase wealth over time, but they differ in significant ways
• An increase in income doesn't necessarily translate to an increase in wealth
• Individuals need to save and invest their income to accumulate wealth over time
• Multiplier ratio

  The ratio of a change in equilibrium real income to a change (the injection) that brought it about
• Multiplier

  The increase in national income that results from an initial injection into the circular flow of income
• Multiplier effects of injections

  1. Initial injection into the circular flow leads to immediate increase in aggregate demand (AD)

  2. Extra income raised by selling goods and services abroad increases incomes of producers, leading to further rounds of income and spending
• When injections decrease

  There will be a downward multiplier effect, leading to a decrease in national income
• Factors affecting the size of the multiplier

  • Savings
  • Imports
  • Taxes
• Withdrawals

  Amount of money taken out of the circular flow of income in the form of savings, imports, and taxes
• Savings

  When people save money, they remove it from the circular flow of income, reducing the amount of money available for further rounds of spending
• Imports

  When money is spent on imported goods, it leaves the circular flow of income and does not contribute to further rounds of spending
• Taxes

  When the government collects taxes, it removes money from the circular flow of income, reducing the amount available for further rounds of spending