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Definition of Injection:
occurs when funds are added to an economy from a source other than households and businesses. Sources of injections include: government spending, investment, and exports.
An injection adds to the national income and consumers and businesses have more money to purchase and manufacture goods and services. The circular flow model is a model that illustrates how consumer products and production inputs flow in exchange for money. Households and businesses are the two major actors in the circular flow model. They trade with each other in two markets—the factor market and the goods and services market. The factor market is where businesses shop for the resources they need to provide a good or service. Households purchase the goods and services they want from businesses in the goods and services market, which is anywhere businesses sell to a final consumer. The money businesses receive from households is returned to the economy when businesses purchase the resources they need in the factor market. The factors of production include labor, land, natural resources, capital, and entrepreneurship. All are provided by households. In return for providing the factors of production, businesses pay households wages, rent, interest, and profits.
The most basic circular flow model is closed, and money is circulated between businesses and households without any additional funds entering or exiting the system. (This is the diagram below without the injections and leakages.) However, in the real world, injections occur when money is added to the system and consumption is increased. Leakages occur when there is an outflow of money from the system, and consumption is reduced.
Government spending is an injection because money is added to the economy which can be used by households to acquire more goods and services. Businesses use the money to expand their operations by purchasing more factors of production. The income gains are offset by taxes, which reduce the amount households and businesses have to purchase the things they want. Taxes cause a leakage.
Investments funded by loans inject money into the economy. Leakages occur when borrowed money is not re-deposited because the money cannot be used for additional loans and reduces an economy’s capacity to extend credit. Savings is another source of leakage. The money a household saves is not used to purchase consumer goods and services. However, when savings are deposited in a bank they can be used to increase lending, which increases investments.
Foreign trade can provide an injection and a leakage. Exports are purchased with money from outside the economy, so the money received by a company within the economy is an injection. Conversely, imports are a leakage because money is sent to the exporting economy when an import is acquired.
Injections and leakages can be used to predict the future direction of an economy. An economy is in equilibrium when injections equal leakages. It is expected to expand when injections exceed leakages. When leakages exceed injections, it signals a reduction in national income and a contracting economy. Solve the problem below. Identify which economy is in equilibrium. Which economy do you expect will expand and which will contract? Use the figures for the three economies provided in the table.
To solve the problem, for each economy, sum the leakages (taxes, savings, and imports) and compare the total with the sum of injections (government spending, investment, and exports). When the sums are equal, the economy is in equilibrium, as is the case with Economy C. Economy B is expected to expand because its injections exceed its leakages. Finally, Economy A will likely contract since its national income is decreasing because its leakages exceed its injections. The solution is explained using the table below.
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Aggregate Demand – Relating Inflation and Real Gross Domestic Product