Study Notes
The circular flow of income model illustrates the movement of income, spending, and output within an economy, showing the interconnectedness of these elements and providing a basis for measuring GDP. An open economy engages in international trade, while a closed economy does not, affecting the circular flow of income differently. Injections and leakages impact the circular flow by altering the balance of spending and income, influencing whether a country's income is in equilibrium or disequilibrium.
- Circular Flow of Income — a model showing the movement of income, spending, and output in an economy.
Example: Income generated from production is spent on goods and services. - Open Economy — an economy that participates in international trade.
Example: A country that imports and exports goods and services. - Closed Economy — an economy that does not engage in international trade.
Example: A theoretical model used to illustrate basic economic principles. - Injections — additional spending in the economy, such as investment, government spending, and exports.
Example: Foreigners buying a country's exports. - Leakages — income that exits the circular flow, such as savings, taxes, and imports.
Example: Income saved instead of spent on domestic goods. - Equilibrium Income — when injections equal leakages, keeping income stable.
Example: Investment equals savings, maintaining income levels. - Disequilibrium Income — when injections do not equal leakages, causing income to change.
Example: More imports than exports, leading to a decrease in income.
Exam Tips
Key Definitions to Remember
- Circular Flow of Income
- Open Economy
- Closed Economy
- Injections
- Leakages
- Equilibrium Income
- Disequilibrium Income
Common Confusions
- Confusing injections with leakages
- Misunderstanding the impact of savings on the circular flow
Typical Exam Questions
- What is meant by leakages from the circular flow of income? Income that is not spent on domestically produced goods and services
- Which of the following is not an injection into the circular flow? Imports
- Consider, with the help of a circular flow diagram, why an export-led growth policy is likely to be successful when a developed economy is in a recession? Export-led growth increases demand for domestic products, boosting income and spending
What Examiners Usually Test
- Understanding the differences between open and closed economies
- The effects of injections and leakages on the circular flow
- How equilibrium and disequilibrium income are determined