Circular Flow Diagram



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The circular flow diagram is a model of how income circulates between producers(firms) and consumers(households). The flow can have injections and leakages. In the case where injections are great than leakages we are experiencing economic growth. When leakages are greater than injections we are experiencing a contraction causing a recession.

Terms to help understand the diagram:
Factor payments = rent + wages + interest + profit
Factors of production = land + labor + capital + enterprise
GDP = Gross Domestic Product
National Income = Factor payments
Injections = money coming into the flow ( I + X + G )
Leakages = money leaving the flow ( t + S + IM )
Net taxes = total taxes paid minus transfer payments
Savings = disposable income that is not spent on goods or service. Example: money that is being saved in the bank.
Import spending = money spent on purchasing goods from other countries. Example: purchasing Volkswagons from Germany.
Export spending = money brought in from selling goods to other countries. Example: Canada selling lumber to the states.
Investment spending = “Expenditures on capital goods including new housing. Financial ''investments" and sales of existing assets are not included.” found at www.finance-lib.com/financial-term-investment-spending.html. Example: purchasing a building.
Government spending = “is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. It does not include any transfer payments, such as social security or unemployment benefits.” found on www.dictionary.com. Example: government paying city workers to build new roads.
Consumption spending = “Goods and services bought by households in the satisfaction of their needs and wants. It includes non-durables such as food
, semi-durables such as clothing, and durables such as refrigerators” found on www.businessdictionary.com under consumer spending. Example: buying groceries.