What is the circular flow of income?

The circular flow of income tracks spending and income between households, firms, finance, government and overseas sectors. Savings, taxes and imports are leakages. Investment, government spending and exports are injections. To compare the two totals, add each group separately. An increase in an injection adds demand, other things equal.

Worked example

Suppose savings are $30 billion, taxation is $45 billion and imports are $25 billion. Leakages total $100 billion. Investment of $35 billion, public spending of $55 billion and exports of $20 billion give $110 billion of injections.

Injections exceed leakages by $10 billion in this example. Other things equal, that puts upward pressure on output and income. The trade balance alone is a $5 billion deficit, which shows why comparing exports and imports cannot answer a question about the whole flow.

Leakages: S + T + M = $100b. Injections: I + G + X = $110b. Injections exceed leakages by $10b.

What is the circular flow of income?

Worked example

Official exam practice