Question

Which of the following is NOT an example of leakage from the circular flow of income?

• A. Savings
• B. Taxes
• C. Imports
• D. Government spending

Answer 1

The Correct Option is D

In the circular flow of income model, leakages refer to the non-consumption uses of income that remove money from the economic cycle. These include: 

• Savings: When individuals or businesses save money, it is temporarily removed from the flow of consumption.
• Taxes: Income paid to the government in the form of taxes is not used for consumption or investment by individuals.
• Imports: Spending on foreign goods and services causes money to leave the domestic economy.

Government spending, on the other hand, is an injection, not a leakage. It involves the government putting money back into the economy by purchasing goods or services, or providing subsidies, which stimulates economic activity. Therefore, the correct answer to the question, "Which of the following is NOT an example of leakage from the circular flow of income?" is Government spending.

Answer 2

Leakages in the circular flow of income refer to withdrawals of money from the economy, which can reduce the overall level of economic activity. These leakages include savings, taxes, and imports, all of which take money out of the flow.

Savings occur when individuals or households choose to save part of their income rather than spending it on goods and services, leading to a reduction in consumption.

Taxes represent money that the government takes from individuals and businesses, which, while necessary for funding public services, can reduce the amount of money available for consumption and investment in the economy.

Imports refer to money spent on goods and services from foreign countries, which leaves the domestic economy and does not contribute directly to local production.

In contrast, injections into the circular flow, such as government spending, investment, and exports, add money into the economy, stimulating demand and economic activity. Government spending, for example, can increase demand for goods and services, creating jobs and boosting income, thus encouraging further spending and investment. These injections help counterbalance the effects of leakages and stimulate economic growth.