injections-and-withdrawals-into-the-circular-flow

The Effect of Changes in Injections & Withdrawals on National Income 

• Money can enter or leave the circular flow of income in an economy

  • Injections represent new income in the economy

  • Withdrawals are the leakage of money from the economy

• Injections add money to the circular flow of income and increase its size

  • Increased government spending (G)

  • Increased investment (I)

  • Increased exports (X) 

• Leakages (withdrawals) remove money from the circular flow of income and reduce its size

  • Increased savings by households (S)

  • Increased taxation by the government (T)

  • Increased import purchases (M) 

• There are high levels of interdependence between households, firms, the government, the financial sector, and the foreign sector (foreign firms and households)

Diagram: Injections & Leakages

Diagram analysis

• Government: Government spending (G) is an injection and taxation (T) is a leakage

• Financial sector: Investment (I) is an injection and savings (S) is a leakage

• Foreign sector: Exports (X) is an injection and imports (M) is a leakage 

• The relative size of the injections and withdrawals impacts the size of the economy

  • Injections > withdrawals = economic growth and increase in national income

  • Withdrawals > injections = economic decline and a fall in national income 

• Changes to any of the factors that influence government spending, investment, consumption and net exports will increase or decrease the relative size of the circular flow of income

  • E.g. An increase in interest rates will increase savings (withdrawal) and reduce consumption and investment

The Determinants of Savings

• The determinants of savings refers to the factors that influence an individual (household) decision to save money rather than consume it immediately

• Disposable income can either be saved or spent on goods/services (consumption)

  • When savings decrease, consumption usually increases

  • When savings increase, consumption usually decreases

• The household savings ratio calculates household savings as a proportion of household income

  • This percentage is often low when an economy is booming and full of confidence – and vice versa

  • During lockdown in 2020 this ratio reached a record high in the UK of around 25%

• The difference between savings and investment is:

  • Savings is the portion of income by households that is not spent / consumed 

  • Investment is expenditure by firms on capital goods eg. machinery and equipment. The spending is geared toward enhancing productivity

    • Firms can also save profits, without spending them 

Equilibrium National Income & Full Employment

• The equilibrium national income level is where withdrawals are equal to injections

  • This is also where aggregate demand is equal to aggregate supply 

• Full employment is the level of income at which an economy is operating at full capacity

  • It is operating on its production possibility frontier with no spare capacity