8 LEVEL OF OVERALL
ECONOMIC ACTIVITY
8.1 ECONOMIC ACTIVITY
Learning Objectives
◻ Review the circular flow
of income model
◻ Illustrate the circular
flow of income model
Circular flow of income model – Closed
economy with no government
Resource markets Product Markets
◻ Households owns all FOPs; ◻ Using the income received,
firms employ these FOPs to households spend on Gds
produce Gds & Svs and Svs produced by firms,
◻ Income flow – Firms incur incurring expenditure for this
costs when producing Gds consumption
and Svs and Households ◻ Firms in turn receive
receive factor income when revenue when they sell their
they provide FOP to firms, gds and svs to households
Circular flow of income model – Closed
economy with no government
◻ For given time period, the
income flow from firms to
households is equal to the
expenditure flow from
households to firms – circular
flow of income
◻ Income and expenditure flow
is equal to the value of Gds
and Svs ie value of output
flow, this is equal to the sum
of product of each gds and
svs multiplied by its
respective prices, this giving
the total output
Important Note
The circular flow of income shows that at any given time
period (say a year),
• the value of output produced in an economy is equal
• to the total income generated in producing that output,
which is equal
• to the total expenditure made to purchase that output
Circular flow of income model – Leakages &
Injections
◻ Injections (money
flowing in) and
leakages (money
flowing out) to the
money flow
◻ Injections –
investment, govt
spending & export
spending
◻ Leakages
(Withdrawals) –
savings, taxes &
import spending
Leakages & Injections - Saving and
Investment
◻ Saving is part of consumer income not spent – leakage
◻ Investment is spending mainly by firms on capital goods
(physical capital)
◻ Households place their savings in financial markets; savings
leak out of the flow of consumer expenditure, passes through
the financial markets and then injected into the expenditure
flow as investment
◻ Firms obtain funds from financial markets to finance
investment, or the production of capital goods – these flow
back into the expenditure flow as investment
Leakages & Injections
Taxes and gov’t spending Imports and Exports
◻ Taxes are leakages since ◻ An economy that imports &
exports through international
households pay taxes to the trade is an open economy
govt instead of buying gds ◻ Imports represent a leakages
and svs because they are household
spending that leaks out to other
◻ Govt spending (education, countries that produces that gds
& svs
healthcare etc.) comes back
◻ Exports represent an injection
into the flow as an injection as they are spending by
foreigners who buy domestically
produced gds & svs
Size of Circular flow – leakages > injections
◻ Relative size of the circular ◻ This will result is that fewer
flow is dependent on relative gds & svs are purchased,
size of injections (J) and firms will cut back on their
leakages (W). output
◻ If W > J, size of circular flow ◻ They will then employ fewer
becomes smaller
FOPs, and this will leads to
◻ Suppose savings is larger an increase in
than investment; ie that
household income that leaks unemployment and
as savings into the financial household income will be
markets does not all come reduced.
into the flow as investment
Size of Circular flow – leakages < injections
◻ If W < J, size of circular ◻ Firms begin top produce
flow becomes larger more by employing more
◻ Suppose spending on FOPs
exports is greater than ◻ Unemployment falls as firms
spending on imports employ a larger quantity of
◻ This means that foreigners labout and household
demand a greater amount of incomes increases
gds & svs
Important Note
• Leakages (i.e S, T & M) from the circular of income may
be equal to injections (I, G & X) into the circular flow of
income
• However, since J an W need not be equal.
• If J < W, the income flow becomes smaller
• If J > W, then income flow becomes larger
Circular flow of income
Video Resources
