FLOATING EXCHANGE RATE: An exchange rate determined through the unrestricted interaction of supply and demand in the foreign exchange market. A floating exchange rate means that a nation's government is NOT trying to manipulate currency prices to achieve some change in the exports or imports.
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Non-consumption uses of aggregate income. The three uses of income grouped under the heading of leakages are saving, taxes, and imports. Leakages subtract from the core circular flow containing consumption, production, and income. The injections-leakages model is a Keynesian economics analysis that combines leakages with injections (investment expenditures, government purchases and exports) to identify the equilibrium level of aggregate production and income. Leakages are so named because they are uses of income "leaked" out of the core cumulatively reinforcing circular flow of consumption, production, factor payments, and income that goes between the household sector and business sector. An increase any of these injection expenditures reduces the total of this core circular flow and a decrease expands the total.
The Injections-Leakages ModelAs a group, the three leakages are most important in the context of the injections-leakages model.
The injections-leakages model provides an alternative to the more common Keynesian cross, aggregate expenditures-aggregate production model of the macroeconomy. Both models provide essentially the same analysis and are essentially "two sides of the same coin." The key difference between the two models is that consumption is explicitly eliminated from the injections-leakages variation. Whereas the Keynesian cross builds on the consumption function, the injections-leakages model builds on the saving function.
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!
The Three InjectionsOne half of the injections-leakages model is leakages, which are non-consumption uses of aggregate income. 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.
- Saving: A significant portion of income leaked out of the circular flow is saving, which is considered any disposable income that is not used for current consumption expenditures. This includes income directed to traditional savings accounts, other types of financial market "investments," and even loan payments.
- Taxes: The government sector extracts a portion of income (that is, forces a leakage) from the household to finance government activity. The primary taxes included are personal income taxes.
- Imports: The foreign sector, which includes everyone who is not a citizen of the domestic economy, produces goods and services purchased by the domestic economy. Payment for these imports leak income, income that cannot be used for consumption expenditures on domestic production, out of the circular flow.
The Circular Flow
Leakages are best illustrated using the standard circular flow model of the macroeconomy, such as that presented in the exhibit to the right. The circular flow is a handy model of macroeconomic activity that highlights the interaction between households and businesses through the product and resource markets.
|The Circular Flow
The business sector is at the right and the household sector is at the left. The product markets are at the top and the resource markets are at the bottom. The household sector buys production from the business sector through the product markets. Expenditures by the household sector are consumption expenditures. Revenue going to the business sector is gross domestic product.
The business sector hires factor services from the household sector through the resource markets. Payments made by the business sector are factor payments. Income going to the household sector is national income.
These four parts -- consumption expenditures, gross domestic product, factor payments, and national income -- are the core of the circular flow. They are the "engine" that drives the macroeconomy.
Let's now consider how leakages relate to this core circular flow.
The three leakages -- saving, taxes, and imports -- can be displayed by clicking the [Leakages"] button. These leakages, like consumption, are how the household sector divides up or uses its income. Most importantly, leakages subtract from the total volume of the basic circular flow. That is, they "leak" income away from the product markets, making less available for factor payments and household income.
Three Sets of LeakagesInjections by the four sectors are often combined in a sequential fashion to generate three different combinations, which are then used in three different injections-leakages models.
- Two-Sector: The simplest injections-leakages model includes the household and business sectors. Also termed the saving-investment model, the leakage side of this variation includes only saving, with investment expenditures the only injection.
- Three-Sector: The second variation of the injections-leakages model adds the government (or public) sector to the household and business sectors contained in the two-sector model. The leakages side of this variation, which is used to analyze government stabilization policies, contains saving and taxes, with investment expenditures and government purchases on the injections side.
- 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, which is used to capture the interaction between the domestic economy and the foreign sector, contains saving, taxes, and imports as leakages, with investment expenditures, government purchases, and exports on the injections side.
Three InjectionsThe other half of the injections-leakages model is injections, which are non-consumption expenditures on aggregate production. The three injections are investment expenditures, government purchases, and exports. These are termed injections because they are "injected" into the core circular flow of consumption, production, and income.
LEAKAGES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: February 27, 2024].
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