Circular Flow of Income

1. Circular Flow of Income Brian and Raihan

2. Businesses produce goods and services and in the process of doing so, incomes are generated for factors of production (land, labour, capital and enterprise) – for example wages and salaries going to people in work.

3. Leakages (withdrawals) from the circular flow • Not all income will flow from households to businesses directly. The circular flow shows that some part of household income will be: • Put aside for future spending, i.e. savings (S) in banks accounts and other types of deposit • Paid to the government in taxation (T) e.g. income tax and national insurance • Spent on foreign-made goods and services, i.e. imports (M) which flow into the economy • Withdrawals are increases in savings, taxes or imports so reducing the circular flow of income and leading to a multiplied contraction of production (output).

4. Injections into the circular flow are additions to investment, government spending or exports so boosting the circular flow of income leading to a multiplied expansion of output. • Capital spending by firms, i.e. investment expenditure (I) e.g. on new technology • The government, i.e. government expenditure (G) e.g. on the NHS or defence • Overseas consumers buying UK goods and service, i.e. UK export expenditure (X)

5. Multiplier effect • Every time there is an injection of new demand into the circular flow there is likely to be a multiplier effect. This is because an injection of extra income leads to more spending, which creates more income, and so on. The multiplier effect refers to the increase in final income arising from any new injection of spending.

6. Negative multiplier effect • Every time there is a leakage of new demand into the circular flow there is likely to be a negative multiplier effect. This is because a leakage leads to less spending, which creates less income, and so on. The multiplier effect refers to the decrease in final income arising from any new leakage of spending.