W/J approach to circular flow of income in an economy (Business Enviroment Module) - Essay Example

Businesses on the other hand, borrow capital from financial institutions for further investments hence inject money into the flow thus offsetting the withdrawals. Withdrawals in the circular flow are therefore equal to injections other factors like prices held constant. Withdrawals are denoted using letter W and include savings(S), taxes (T) and imports (M). Injections are denoted by J and include investments (I), government spending (G) and exports (E). The simple equation of Keynes model therefore is; W=J; S+T+M=I+G+E.

Total income (Y) is equal to total expenditure (E) and is equal to total output as it is assumed that all income is spent on consumption Y=G+E+I+C where G, E, I are assumed constant (Siilats, 2010). The diagram below illustrates the circular flow of income by Siilat. A government injects money into the circular flow through its various activities. It produces goods and services which are consumed by households and firms and households acquire more income through employment in production process.

The government is also an employer and pays wages which go into households and is a consumer of goods and services (Mcdonald, 1999). These expenditures by government are direct or indirect and are stimulus in the cycle. They increase demand and consequently production of more goods thus increasing output and employment and in long-run high income leads to savings which is a withdrawal thus maintaining equilibrium where withdrawals is equal to injections. A government may decide to apply its fiscal policy to regulate the economy by cutting its expenditure so as to minimise borrowing.

Government expenditure is an injection in the circular flow of income that means a cut in direct expenditure will result in decline in injections in the flow (Bluedorn, 2005). A cut in provision of essential services such as health, education translates into households increasing their