How Money Circulates Through an Economy

Key Takeaways

1. 1The circular flow model has two circuits: goods and services moving one way, money moving the opposite way, with households and firms on each side
2. 2Households supply labor and earn income; firms produce goods and earn revenue — income out matches spending in, by construction
3. 3Savings are a leak from the flow and investment is the matching injection — when they balance, the economy stays in equilibrium
4. 4Taxes withdraw money from the flow; government spending injects it — fiscal policy works by adjusting the net effect of these two
5. 5International trade adds a third pair — imports leak money abroad, exports inject foreign money into the domestic economy
6. 6Aggregate demand equals aggregate supply when total injections equal total leaks — equilibrium is an accounting requirement, not a coincidence
7. 7Stimulus and austerity have opposite effects because they push the same loop in opposite directions — more injections expand, more leaks contract
8. 8The circular flow is the foundation of macroeconomics — every other concept (multiplier, GDP, fiscal policy) sits on top of it