Question

State whether the following represent an injection into the circular flow of income or a withdrawal from it. You have to assume that “other things remain unchanged” (ceteris paribus)

a)         a cut in taxes
b)         BAe Systems (a defence contractor) receives a large order from abroad
c)         central government spending on higher education is cut
d)         retirement pensions are increased

Answer 1

Circular flow of income is an economic model in which the flow of incomes is depicted from one sector of the economy to another sector. This is called circular flow because here incomes flows from one person to other and back to the first person after passing some stages.

a) Cut in taxes may be regarded as a withdrawal from circular flow, this is because a tax is a source of income for government and if the is decrease in income it is an outflow from circular flow of income because if governments' income is decreased its expenditure will also be decreased.

b) If a defence contractor receives an order from abroad, than he will send goods and will receive income from abroad. So this will be an injection into the circular flow.

c) If central government cuts expenditure on higher education, it means that less money will go into education sector, so it will act as a withdrawal from circular flow of income.

d) If retirement pensions are increased than more money will go to people, so it will act as injection into the circular flow of income.