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National Income and AD/AS Analysis: Question 1

Syllabus 4.2

Multiple choice AS 1 mark

Economists modelling the small open economy of Kelmara use the circular flow of income to trace how spending, output and income circulate between households, firms, the government and the rest of the world.

Which of the following is a withdrawal (leakage) from Kelmara's circular flow of income, rather than an injection into it?

Choose an answer to check it, then compare with the worked solution below.
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Worked solution

Step 1: Recall injections and withdrawals

An injection is an addition of spending into the circular flow of income that does not come from households simply re-spending their own domestic income: Investment (I) by firms, Government spending (G), and Export earnings (X) paid by overseas buyers are the three injections. A withdrawal (leakage) is income that leaves the circular flow instead of being passed on as further domestic spending: Savings (S), Taxation (T), and Import spending (M) paid to overseas producers are the three withdrawals.

Step 2: Check option B

Option B describes Kelmara’s firms paying overseas suppliers for imported machinery. This spending leaves Kelmara’s domestic circular flow entirely: it becomes income for a firm in another country rather than being recirculated as spending on Kelmara’s own output. Import spending (M) is therefore a withdrawal, matching option B.

Step 3: Rule out options A, C and D

  • Option A: government spending is one of the three injections (I, G, X); it adds to the circular flow rather than leaking from it.
  • Option C: money paid by overseas customers for Kelmara’s exports flows into Kelmara’s domestic firms from outside the flow, exactly the opposite direction to an import. Export earnings are an injection, not a withdrawal.
  • Option D: investment spending by firms on new capital equipment is another of the three injections; it is additional spending, not household income that fails to be re-spent domestically.

Final answer

Option B. Import spending is a withdrawal from the circular flow of income, since it is domestic spending that leaves the flow to pay overseas producers, unlike government spending, export earnings and investment, which are all injections.