![]() Investment - some of this money is invested by firms towards the purchase of capital goods, for example. It is money that enters our circular flow of income. Every country with a government will have a tax law which citizens have to follow.ĭo you notice the bright green lines in the diagram? These are our injections. Taxes - some of the money is taxed and transferred to the government. Do you see on the diagram how we give money to other countries and it enters their circular flow of income. Imports - some of the money is transferred between our circular flow and another country's. They hold back some of their income for future emergencies or future purchases. ![]() Saving - some of the money is saved by households. This is the money that exits our circular flow. We have governments we pay taxes to, other countries that we buying imports from and we also do not spend all of our money.ĭo you notice the red lines in the diagram? These red lines are our leakages or withdrawals. The above model is a more realistic view of our income. We need firms to be making more output so we need more expenditure and income etc. This proves the condition above is true and shows what we need for economic growth to occur. And if the firms make extra outputs, they must hire extra inputs and pay extra income. How can we show economic growth using this condition?Īny extra money spent will be reflected by extra output that the firms make. ![]() There are no purchases of imports or exports.įrom the diagram above we can also see the following condition is true: It assumes a few things:Ģ) The market is a closed economy. ![]() This is shown as the flow of income between firms and households on the diagram. These factor inputs are land, labour and capital.Ĥ) The firms must pay the factor rewards to the factors of production. The more expenditure they receive, the more outputs they will produce.ģ) Firms produce these outputs by hiring factor inputs. This is called expenditure.Ģ) Firms respond to the expenditure by producing outputs. The diagram above shows the most basic circular flow of income model.ġ) Money flows from households to firms on the right hand side. ![]()
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