2.5.2 Circular flow of income, expenditure and output


    The economy reaches a state of equilibrium when the rate of withdrawals = the rate of injections. Income, expenditure and output are considered to be the same in the circular flow of income.


    • An injection is money that enters the economy
    • A withdrawal is money that leaves the economy
    • The amount of savings in an economy is equal to the amount of investment.
    • In the UK, there is a traditionally low savings rate, especially during periods of high economic growth, and this means that the rate of investment is also low. In Japan there is a high savings rate and with this comes a high level of investment.
    • Net injections in the economy there will be an expansion of the national output whilst net withdrawals there will be a contraction of production so output decreases.


    • Aggregate demand is the total demand in the economy which measures spending on goods and services by consumers, firms, the government and overseas economic agents.
    • It is made up of the following components: Consumer spending (C), Investment (I), Government spending (G) and Net exports (X-M).
    • C is influenced by interest rates and consumer confidence, the lower the former the more spending as there is also more disposable income. The higher the confidence levels, the more investment and spending consumers will do.
    • I is affected by: rate of economic growth, business expectations/confidence, demand for exports (market demand), interest rates, access to credit and regulations
    • G is influenced by economic growth and fiscal policy, the former affecting how much the government spends on welfare payments and how much they gain in tax revenue. Fiscal policy is based on government expenditure and depending on whether it is expansionary or contractionary it will affect the government deficit etc.
    • X-M is affected by: real income (more domestic/imports consumed), exchange rates, state of the world economy (downturn in Eu will cause UK export market to fall), degree of protectionism and non-price factors. These factors may include competitiveness of goods and services through productivity or innovation as well as trade deals and trading blocs they are part of.



    • Aggregate supply is the total supply in the economy which measures all that firms are able to supply at a given price level.
    • It can be affected by changes in the cost of inputs and resources e.g. if imported components become more expensive, firms will either choose to produce less or increase prices to cover their higher costs. They would perform well with a stronger currency as they will have lower costs (if using imported materials).
    • Governmental regulation such as environmental laws or green taxes affect aggregate supply as firms may have increased costs and reduce production as a result.
    • A net outward migration of workers would cause a ‘brain drain’ on the domestic economy, as skilled workers move elsewhere reducing supply of labour etc.

    An increase in productivity will cause an increase in production levels à more goods.


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