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Leakages and Injections in Circular flow of Income

Last Updated : 06 Apr, 2023
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The circular flow of income is an economic model that reflects how money or income flows through the different sectors of the economy. A simple economy assumes that there exist only two sectors, i.e., Households and Firms. Households are consumers of goods and services and the owners of the factors of production (land, labour, capital, and enterprise). However, the firm sector produces goods and services and sells them to households. 

Leakages

It means to withdraw money from the circular flow of an economy. Leakage from the circular flow of income of an economy happens when the firms and households save a part of their incomes. Therefore, leakage or withdrawal is that part of the income of an economy that does not pass through the circular flow of income, resulting in the unavailability of that money for spending on the goods and services produced recently. Thus, it can be said that leakages reduce the flow of income in an economy. 

Leakages in Different Types of Economies

Two-Sector Economy (with Financial Market) Savings
Two-Sector Economy (without Financial Market) No Leakages
Three-Sector Economy Savings + Taxes
Four-Sector Economy Savings + Taxes + Imports

Savings is that portion of the income of a firm or household that is not spent on the purchase of goods and services or distributed as profits but is retained for the future. 

Imports are the goods purchased by the residents of a country from foreign countries, resulting in an outflow of income from the economy.  

Tax is the amount paid to the government by firms and households. 

Injections

It means the addition or introduction of income to the circular flow of an economy. Injections into the circular flow of income are a result of money borrowed by households and firms from different external sources, like financial institutions. However, this additional income does not result in an immediate expenditure. Therefore, injections increase the flow of income in an economy. 

Injections in Different Types of Economies

Two-Sector Economy (with Financial Market) Investment
Two-Sector Economy (without Financial Market) No Injection
Three-Sector Economy Investment + Government Expenditure
Four-Sector Economy Investment + Government Expenditure + Exports

Investment is the part of the income which is used for the purchase of a capital asset. An investment generates a return in the future. In other words, investment is the expense made by a firm on capital expansion. 

Exports are the goods sold by firms to foreign countries, resulting in an inflow of income into the economy. 

Government Expenditure is the total consumption expenditure made by the government of a country on the purchase of goods and services, transfer payments to the households, and providing subsidies to firms. 

An economy can achieve Equilibrium when the Leakages of an economy are equal to the Injections. 


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