The Circular Flow of Income

Question 1

What is the circular flow of income?

Answer 1

An economic model explaining the relationship between national income, national output and national expenditure.

Question 2

What are the three ways to measure economic activity in the circular flow?

Answer 2

National output (O), national income (Y) and national expenditure (E).

Question 3

What is wealth?

Answer 3

The ownership of physical goods, assets and land that can be used to create output and income.

Question 4

Explain the circular flow of income diagram (3).

Answer 4

1) Firms produce goods and services in an economy, with the GDP making national output.
2) Households (consumers and owners of wealth) provide land, labour and capital needed by firms to produce national output, with the money paid by firms to households to use these factors of production making up national income.
3) Households spend the money from national income on goods and services made by firms–national expenditure.

Question 5

What is an injection?

Answer 5

An inflow of money into the economy that do not come from households.

Question 6

What is a withdrawal/leakage?

Answer 6

An outflow of money out of the economy.

Question 7

What are the three types of injections?

Answer 7

1) Exports: Foreign buyers purchase UK goods, adding to the circular flow of income.
2) Investment: Expenditure on capital stock used to create other goods.
3) Government spending: E.g. building a new road creates additional inflow as money is used to pay for land, labour and capital.

Question 8

What are the three types of withdrawals?

Answer 8

1) Imports: The money spent on foreign goods flow out of the domestic economy.
2) Savings: When households/firms do not spend their income it becomes savings, removing money from the circular flow.
3) Taxes: Deducted from national income for both firms and households.

Question 9

What are the impacts of injections and withdrawals on the economy (3)?

Answer 9

1) When injections and withdrawals are equal, the economy is in equilibrium.
2) When withdrawals are greater than injections then there is a reduction in national output.
3) When injections are greater than withdrawals then there is an increase in output and the economy grows.