Two Sectors

• Household Sector: The household sector includes everyone in an economy who consumes goods and services. It is the entire population of an economy. The household sector is responsible for consumption expenditures on gross domestic product.


• Business Sector: The business sector contains the private, profit-seeking firms in the economy that combine scarce resources into the production of wants-and-needs satisfying goods and services. The business sector is responsible for investment expenditures on gross domestic product.

Injections and Leakages

The other half of the injections-leakages model is leakages, which are non-consumption uses of the income generated from production. The three leakages are saving, taxes, and imports. These are termed leakages because they are "leaked" out of the core circular flow of consumption, production, and income. In the two-sector injections-leakages model, saving is the only leakage included.

Equilibrium in the injections-leakages model relies on a balance between the injections into the core circular flow and leakages out of the flow. If leakages match injections, then the volume of the core circular flow does not change. This is the same as achieving a balance between the water flowing from a faucet into a sink and that flowing out through the drain. When these two flows are equal, then the total amount of water IN the sink does not change. Equilibrium!

In the two-sector injections-leakages model, equilibrium is identified as a balance or equality between saving and investment expenditures.

The Injections-Leakages Balance

• For the two-sector analysis, aggregate expenditures (AE) are the sum of consumption (C) and investment (I).

  AE = C + I



• In the two-sector analysis, the income generated by aggregate production (Y) is used by the household sector for consumption (C) and saving (S).

  Y = C + S



• Substituting each of these equations into the Y = AE equilibrium condition gives us:

  C + S = C + I



• Because consumption (C) is on both sides, it cancels out.

  S = I

This results indicates why two-sector injections-leakages model is also termed the saving-investment model. This version of the injections-leakages model has its foundation in classical economics, particularly the key classical assumption that saving is equal to investment.

The Graphical Model

The Injections-Leakages Model

A click of the [Leakages] button displays the leakages line, which is comprised exclusively of saving. The slope of this saving line is positive and equal to the marginal propensity to save. The vertical intercept of the saving line is negative, indicating that autonomous saving is negative.

A click of the [Injections] button displays the injections line, which is based entirely on investment expenditures. To keep the analysis simple, investment expenditures are assumed to be autonomous, as indicated by the horizontal investment line. Induced investment would give the injections line a slight positive slope, but it would not affect the basic conclusions reached.

With the saving and investment lines in place, the next step is to identify equilibrium. Because we are dealing only with two sectors -- household and business -- this injections-leakages model achieves equilibrium with equality between saving and investment.

Equilibrium is found at the intersection of the saving line and the investment line. Click the [Equilibrium] button to highlight this point and the corresponding $12 trillion level of aggregate production.

What key conclusions can be derived from this analysis.

• First, saving is equal to investment, and leakages are equal to injections. As such, the total volume of the circular flow does not change.


• Second, if saving is not equal to investment, then the volume of the circular flow, especially aggregate production, changes. If saving exceeds investment, aggregate production declines. If investment exceeds saving, aggregate production rises.


• Third, the difference between saving and investment is unplanned inventory changes. If saving equals investment, then inventories don't change. If saving exceeds investment, inventories increase. If investment exceeds saving, inventories decrease.

Two Other Variations

• Three-Sector Model: One variation of the injections-leakages model adds the government sector (or public sector) to the household and business sectors contained in the two-sector model. This variation is used to analyze government stabilization policies, especially how fiscal policy changes in government purchases and taxes can be used to close recessionary gaps and inflationary gaps. Saving and taxes are the two leakages. Investment and government purchases are the two injections.


• Four-Sector Model: As the name suggests, all four macroeconomic sectors--household, business, government, and foreign--are included in the four-sector model. This model is not only used to capture the interaction between the domestic economy and the foreign sector, but also provides the foundation for detailed, empirically estimated models of the macroeconomy. Saving, taxes, and imports are the three leakages. Investment, government purchases, and exports are the three injections.