4.9. Circular Flow of Income

Question 1

Circular Flow of Income Models

Answer 1

1) Simple model
2) Two sector (closed) economy (Banks)
3) Three sector (closed) economy (Government)
4) Four sector (open) economy (International Trade)

Question 2

Circular Flow of Income: Simple Model

Answer 2

• Households and firms only.
• Households provide the (1) FOPs.
• FOPS earn (2) Factor Income.
• (3) Expenditure by households on Goods / Services
• Firms create (4) output.

real physical flows = FOPs and Output
income flows = factor income and enterprise

Question 3

Circular Flow of Income: Two sector (closed) economy (Banks)

Answer 3

Simple model with:
Leakage: Savings (S).
Injection: Investment (I).

Question 4

Circular Flow of Income: Three sector (closed) economy (Government)

Answer 4

Simple model with:
Leakage: Savings (S) and Taxation (T)
Injection: Investment (I) and Government spending (G)

Question 5

Circular Flow of Income: Four sector (open) economy (International Trade)

Answer 5

Simple model with:
Leakage: Savings (S), Taxation (T) and Imports (M)
Injection: Investment (I), Government spending (G) and Exports (X)

Question 6

Equilibrium national income occurs when

Answer 6

Injection = Leakages

Question 7

Equilibrium national income in a two sector (closed) economy:

Answer 7

Investment = Savings

Question 8

Equilibrium national income in a three sector (closed) economy:

Answer 8

Investment + Government spending = Savings + Taxation

Question 9

Equilibrium national income in a four sector (open) economy:

Answer 9

Investment + Government spending + Exports = Savings + Taxation + Imports

Question 10

Disequilibrium national income occurs when:

Answer 10

Injection ≠ Leakages

Question 11

Disequilibrium national income has an expansionary effect on the economy when:

Answer 11

Injection > Leakages

Question 12

Consequences of Disequilibrium national income with an expansionary effect on the economy - Injection > Leakages

Answer 12

• Rising GDP (national income)
• Falling rates of unemployment
• Rising inflation rates.

Question 13

Disequilibrium national income has an expansionary effect on the economy when:

Answer 13

Injection < Leakages

Question 14

Consequences of Disequilibrium national income with an expansionary effect on the economy - Injection < Leakages

Answer 14

• Falling GDP (national income)
• Rising rates of unemployment
• Falling inflation rates.

Question 15

Leakage meaning

Answer 15

means withdrawal from the flow.

- When households and firms save part of their incomes it constitutes leakage

Question 16

Injection meaning

Answer 16

Injections increase the flow of income