How does income flow around an economy, and what makes it grow or shrink?
The circular flow of income, injections and withdrawals, the distinction between income, expenditure and output, and the concept of equilibrium national income.
An answer to AQA A-Level Economics 4.2.2, covering the circular flow of income, injections and withdrawals, the equivalence of income, expenditure and output, and how equilibrium national income is determined.
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What this dot point is asking
AQA wants you to explain the circular flow of income, identify injections and withdrawals, explain why income, expenditure and output are equal, and define equilibrium national income. This model underpins aggregate demand, the multiplier and fiscal policy.
The circular flow of income
In the simplest two-sector model, all income is passed straight back as spending, so the flow is constant. Adding the financial sector, the government and the overseas sector introduces leakages and injections that can make the flow grow or shrink.
Injections and withdrawals
When injections exceed withdrawals, the circular flow expands and national income rises; when withdrawals exceed injections, it contracts. The change in income is larger than the initial change in injections because of the multiplier: extra spending becomes someone else's income, part of which is re-spent, and so on. The size of the multiplier depends on the marginal propensity to withdraw.
Income, expenditure and output
The national income identity states that national income equals national expenditure equals national output. This is because every act of spending is income to someone and corresponds to output produced, so the three official ways of measuring the economy (the income, expenditure and output methods) give the same total. A firm that produces 100 of goods earns 100 of revenue, which it distributes as 100 of factor incomes, matching the value of output.
Equilibrium national income
If injections rise above withdrawals, income rises by a multiplied amount until the two are equal again at a higher level. Crucially, equilibrium income need not be the full-employment level: an economy can settle in equilibrium with a negative output gap and cyclical unemployment, which is the Keynesian case for demand-side intervention to raise injections.
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20184 marksIn an economy, planned injections are: investment 40, government spending 60, exports 50. Planned withdrawals are: saving 35, taxation 70, imports 30 (all in billions). Calculate net injections and explain the effect on national income.Show worked answer →
A 4 mark question rewards the calculation and the direction of change.
- Total injections
- billion.
- Total withdrawals
- billion.
- Net injections
- billion, so injections exceed withdrawals.
- Effect
- With , the circular flow expands, so national income rises (by a multiplied amount) until injections again equal withdrawals at a higher level. Markers reward both totals and the conclusion that income rises.
AQA 20216 marksExplain why national income, national expenditure and national output are equal.Show worked answer →
A 6 mark question rewards a clear account of the identity.
The identity. They are three ways of measuring the same flow. Every pound of output produced is sold (or counted as stock) and generates an equal pound of expenditure; that expenditure becomes income for the factors of production (wages, rent, interest, profit).
Illustration. A firm selling 100 of goods earns 100 of revenue (expenditure by buyers), which it pays out as wages, rent, interest and profit (income), all matching the value of output.
Markers reward the point that income, expenditure and output measure the same circular flow from different angles, ideally with a simple example.
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Sources & how we know this
- AQA A-level Economics (7136) specification — AQA (2015)