How does income circulate through an economy, and what role do injections and withdrawals play?
2.2 The circular flow of income: the flow between households and firms, injections and withdrawals, the equilibrium level of national income, and the difference between income, expenditure and output.
An OCR H460 answer to the circular flow of income, covering the flow between households and firms, injections (investment, government spending and exports) and withdrawals (saving, taxation and imports), the equilibrium level of national income, and why income, expenditure and output are equal.
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What this dot point is asking
OCR wants you to describe the circular flow of income between households and firms, to identify injections and withdrawals, to explain how equilibrium national income is reached where they are equal, and to understand why income, expenditure and output are three ways of measuring the same thing.
The circular flow between households and firms
The model explains why national income (the incomes earned), national expenditure (spending on output) and national output (the value of goods and services produced) are all equal: they measure the same circular flow at three different points. This is the national income identity behind GDP.
Injections and withdrawals
Equilibrium national income
The adjustment is self-correcting. If injections exceed withdrawals, firms see rising demand, raise output and pay more income; as income rises, withdrawals (saving, tax and imports) rise too, until they again equal injections at a higher equilibrium. The reverse happens if withdrawals exceed injections. This is the foundation of the multiplier.
Examples in context
- A government stimulus. Higher government spending (an injection) in a downturn raises national income, the rationale for fiscal stimulus in 2008 to 2009 and during the pandemic.
- A rise in imports. A surge in import spending (a withdrawal) leaks demand abroad, dampening domestic national income.
- A saving glut. If households save more (a withdrawal) without a matching rise in investment, planned withdrawals exceed injections and income falls, the paradox of thrift.
Try this
Q1. List the three injections and three withdrawals in the circular flow. [3 marks]
- Cue. Injections: investment, government spending, exports. Withdrawals: saving, taxation, imports.
Q2. State the condition for equilibrium national income. [3 marks]
- Cue. Planned injections equal planned withdrawals ().
Exam-style practice questions
Practice questions written in the style of OCR exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
OCR H460/02 20194 marksIn an economy, planned injections are: investment bn, government spending bn and exports bn. Planned withdrawals are: saving bn, taxation bn and imports bn. State whether national income will rise, fall or stay the same, and explain.Show worked answer →
A short structured calculation. Compare total injections with total withdrawals.
Total injections bn. Total withdrawals bn.
Because withdrawals (bn) exceed injections (bn) by bn, more is leaking out of the circular flow than is being added, so national income will fall until injections again equal withdrawals at a lower equilibrium.
Markers reward both totals, the comparison, and the conclusion that income falls because withdrawals exceed injections.
OCR H460/02 202110 marksExplain how an increase in injections affects the equilibrium level of national income.Show worked answer →
A levels-of-response question. Knowledge and application: define the circular flow, injections (investment, government spending, exports) and withdrawals (saving, taxation, imports), and state that equilibrium national income is where planned injections equal planned withdrawals.
Analysis: explain that a rise in injections (say higher government spending) means injections exceed withdrawals, so income rises; as income rises, withdrawals rise too (more saving, tax and imports) until a new, higher equilibrium is reached where injections again equal withdrawals. Note the multiplier means the final rise exceeds the initial injection.
Evaluation, if credited, depends on spare capacity and the size of the multiplier. Markers reward the equilibrium condition, the adjustment process and a reference to the multiplier.
Related dot points
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Sources & how we know this
- OCR A Level Economics (H460) Specification — OCR (2023)