Unit 4.2 - Circular flow

• Circular flow of income

  Shows how income, spending and output move around an economy
• Circular flow of income

  1. Output generates income, which is then spent on the output

  2. An economy is an endless circular flow of money
• Closed economy


  An economy that does not trade with other economies (Two sector economy)
• Open economy


  An economy that trades with other economies (Four sector economy)
• Injections


  The introduction of income into the flow, such as additions to investment, government expenditure and exports
• Leakages


  The withdrawal of income from the flow, such as savings, taxation and imports
• For income to be unchanged


  Injections must equal leakages (Equilibrium)
• If injections > leakages

  Income will rise
• If injections < leakages

  Income will fall (Disequilibrium)
• Increase in investment


  Raise in income -> increased savings -> finances more investment
• Higher government spending


  Raises taxes revenue by raising incomes
• Increase in exports


  Increase income -> increased expenditure on domestic products and on imports