Your spending is somebody's wages: You buy an energy drink. That is the shop's revenue. The shop pays its staff. The staff buy things.
Round it goes. That loop is the economy.
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Who is in the loop
- Households — own the resources, do the work, spend.
- Firms — hire, produce, pay out income.
- Government — taxes the flow, spends back into it.
- Banks — take savings, lend for investment.
- Abroad — buys our exports, sells us imports.
Why GDP can be measured three ways: Income paid out. Value produced. Total spent.
Same loop, counted at three points — so all three give the same number. That is why Unit 3 has three methods for GDP.
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Not every euro completes the lap: Some leaks out. Other money is injected in.
Which is bigger decides whether the economy grows or shrinks.
Leakages — money leaving
- Saving — put aside, not spent.
- Taxes — paid to government.
- iMports — spent abroad.
Injections — money entering
- Investment — firms buying capital.
- Government spending.
- eXports — foreigners buying ours.
S T M out. I G X in.: S + T + M = I + G + X ⇒ the economy holds steady.
Injections bigger ⇒ it grows.
Leakages bigger ⇒ it shrinks.
The same €100, both sides: You save €100 instead of spending it. Leakage.
The bank lends it to a firm buying a machine. Injection.
Saving only slows things down if the money stops there. That is the whole argument behind interest rates.
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Small in Unit 1. The whole of Unit 3 is built on it.: Directly: define a leakage, is saving a leakage or an injection?
After that it is behind the multiplier, GDP, and why a recession abroad becomes a recession at home.
The trap — arrows without heads: If you draw the flow, every arrow needs a direction. Leakages point out, injections point in.
An arrow the wrong way says the opposite of what you meant, and the examiner marks the page.
IB-style questionExplain[4 marks]
Explain, using the circular flow of income model, the likely effect on national income of a fall in exports.
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