Economics Flashcards: Circular Flow Model
Basic Concepts
Q1: What are leakages in the circular flow model? A: Money that is withdrawn from the circular flow of
the economy in the form of savings, taxes, and import expenditures. Money 'leaks' out because
participants don't spend all their income on locally produced products.
Q2: What are injections in the circular flow model? A: Money that is added to the circular flow of the
economy in the form of investment, government expenditure, and export income. This creates additional
demand for domestically produced goods and services.
The Three Types of Leakages
Q3: What are the three types of leakages? (Give abbreviations) A: S (Savings), T (Taxes), M (Import
expenditure)
Q4: Define savings (S) as a leakage. A: Income that is not consumed by economic participants and is
set aside for future use. Businesses and households deposit savings with financial institutions, causing
money to leak out to the financial sector.
Q5: What is net savings and why is it important? A: Net savings = savings minus the amount
borrowed by businesses and households. It shows the actual amount of money leaking out. If net savings
is negative, there's more money in circulation, potentially causing inflation.
Q6: Define taxes (T) as a leakage. A: Compulsory money paid to the government by households or
businesses. The government uses tax revenue to provide public goods and services, but taxpayers don't
get direct benefits in return.
Q7: Define import expenditure (M) as a leakage. A: Money spent by consumers and businesses on
imported goods and services from other countries. This money flows out to the foreign sector.
The Three Types of Injections
Q8: What are the three types of injections? (Give abbreviations) A: I (Investment), G (Government
expenditure), X (Export income)
Q9: Define investment (I) as an injection. A: Money that businesses spend on capital goods, usually
funded through borrowing, savings, or selling shares. Businesses typically invest in property and capital
goods used in production.
Q10: Define government expenditure (G) as an injection. A: Government spending on goods and
services using tax revenue. The government provides public goods, builds infrastructure, and offers social
and economic services.
Q11: Define export income (X) as an injection. A: Money received from other countries when locally
produced goods and services are sold abroad. This brings money from outside the country's borders into
the circular flow.
Economic Equilibrium
Q12: What two conditions must be satisfied for economic equilibrium? A: 1) Income and expenditure
must be equal, and 2) Leakages and injections must be equal (L = J).
Q13: What is disequilibrium? A: When the economy is out of balance, occurring when injections are
greater than leakages (J > L) or when injections are less than leakages (J < L).
Q14: What happens when injections are greater than leakages (J > L)? A: 1) Additional injections
create more demand, 2) Production increases to meet demand, 3) National income (Y) increases, 4)
Higher demand pushes up prices, likely causing inflation.
Q15: Express "injections greater than leakages" as an equation. A: J > L or I + G + X > S + T + M
Q16: What happens when injections are less than leakages (J < L)? A: 1) Additional leakages reduce
demand, 2) Production decreases, 3) National income (Y) decreases, 4) Reduced demand may lead to
higher unemployment.
Q17: Express "injections less than leakages" as an equation. A: J < L or I + G + X < S + T + M
Graphical Representation
Q18: In the income-expenditure graph, what does the 45° line represent? A: The line shows where
income and expenditure are equal, meaning the economy is in equilibrium.
Q19: What are the axes in the income-expenditure graph? A: Y-axis (vertical) = Planned expenditure,
X-axis (horizontal) = Income
Q20: What does line AE represent in the graph? A: The initially expected expenditure in the economy,
starting at autonomous consumption (point E) and sloping upward.
Q21: What happens when expected expenditure increases from AE to AE₁? A: The intersection with
the 45° line moves from Y to Y₁, showing that increased aggregate expenditure leads to increased
income.
Consumption Concepts
Q22: What is autonomous consumption? A: The level of consumer spending that doesn't depend on
income level. This is money consumers spend even without income, often funded by borrowing.
Q23: What is the marginal propensity to consume (mpc)? A: The percentage of additional income a
consumer will spend on goods and services, reflecting their 'willingness to spend.'
Q24: What is the formula for calculating mpc? A: mpc = change in consumption expenditure ÷
change in income = ΔC/ΔY
Key Relationships
Q25: Summarize the key relationship between income and expenditure. A: When income increases,
expenditure also increases. When aggregate expenditure increases (due to injections), the level of income
will also increase.
Q26: How are production, income, and expenditure interconnected? A: 1) Households earn income
from selling factor services, 2) Income is used to buy goods/services from businesses, 3) This creates a
circular flow where each process relies on the others.
