Leakages and Injections | Circular flow of the Economy |

What is leakages and injections?

Leakages refer to money leaving the economy while injections refer to money entering the economy. The four roleplayers in the economy have a direct impact on leakages and injections in the economy. 

Leakages

Leakages occur when money gets removed from the flow of the economy. This can happen in three ways:

• Savings (S)
• Taxes (T)
• Imports (M)

When people or businesses in the economy choose to keep some of their available income in the form of savings, they withhold that money from entering the economies flow. This is then seen as a leakage because that money gets taken out of the flow and essentially causes that there is less money in the economy.

Governments collect money from businesses and consumers in the form of taxes. When they do that they take the money which could have been used to do something else with and continue the flow of the money in the economy. This is seen as a leakage because the taxes that get collected are taken out of the economy's flow.

When people and businesses buy things from overseas, they have to use the local currency to buy the currency in order to make the purchase for the import. By doing this, the money gets removed from the flow of the economy because it was used to purchase something from outside the local economy. The money exits the local economy and enters the foreign economy.

These three things can be added up to calculate the total leakages. Total leakages can be expressed with the following formula:

L=S+T+M

Injections

Injections occur when money gets introduced to the flow of the economy. This can also happen in three ways:

• Investments (I)
• Government Spending (G)
• Exports (X)

Investments are the opposite of savings. People and businesses can choose to use some of their available income to upgrade their machinery or build new buildings or invest in new companies. When they do this they are essentially putting more money into the economy because of the money they spend on these investments.

Governments collect taxes in order to have an income so that they can provide public services to the people in a country. This public services are what is called, government spending. This government spending is seen as an injection because they are putting this money into the economy for a greater good.

When businesses sell their products to someone outside of the local economy they recieve money for it. This is called exports and is seen as an injection because there is new money entering the economy that wouldn't have entered at all if it weren't for the exports.

Just like leakages, the three injections can also be expressed in a formula:

J=I+G+X

What does this mean?

There is an indirect relationship between these leakages and injections. 

When people save, banks have more money to lend for investments. When tax income rise, governments will have more money to use for government spending. When imports rise, foreigners gain more money and will be able to increase the things they buy from us, in other words, exports will rise. 

Because of this correlation, it can be assumed that the leakages and injections are useless and cancel each other out. That is wrong because, in theory, the relationship will balance each other out. In reality, this can't happen and either leakages or injections will be more than the other.

When leakages and injections are equal, it is said that the economy is in equilibrium. It can be written as follows:

S+T+M=I+G+X

or

L=J

We now know that this state of equilibrium is almost impossible to achieve and that in reality, the one will be bigger than the other. When leakages are bigger than injections, it is said that the economy is shrinking. When injections are bigger than leakages, it is said that the economy is growing.

S+T+M>I+G+X

L>J

Shrinking

or

I+G+X>S+T+M

J>L

Growing

Leakages and injections are a very important concept to understand as it influences a lot of things happening in the economy. One of those things are inflation. In the next post, which you will be able to go to once it is published, we will talk about inflation. You will be able to click here to read about inflation.

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