1.1.5—Circular flow of income model

The circular flow model shows income, spending and output moving between households and firms, with injections and leakages linking the economy to government, finance and international trade.

Household spending becomes firm revenue and wages; saving, taxes and imports leak from the basic flow, while investment, government spending and exports inject demand.

Trace one flow and check whether an injection or leakage changes total activity.

If households save more while investment does not rise, spending may fall and firms reduce output and income.

The model tracks flows, not welfare; more spending does not automatically mean better outcomes.