Cambridge International as and a level Economics Ebook

Figure 9.17 
Impact of a rise in aggregate expenditure
249
Chapter 9: The macroeconomy 

---

to equal 
withdrawals
from the circular fl ow. If injec tions 
were greater than leakages, there would be extra spending 
in the eco nomy, causing income to rise. In contrast, if 
withdrawals exceed injections, more spending would 
be added to the circular fl ow and income would fall. 
Figure 9.18
 shows equilibrium income in a two-sector 
economy.
Injections: 
additions to the circular flow of income.
Withdrawals: 
leakages from the circular flow of income.
KEY TERMS
A rise in investment would cause a rise in GDP. Th
is is 
shown in 
Figure 9.19.
A fall in saving will have a similar eff ect.
Figure 9.20
 shows equilibrium income where 
I
+
G
+
X
=
S
+
T
+
M
in a four-sector economy.
Income will move to a higher equilibrium level if any 
injection rises or any withdrawal falls.
 Figure 9.21
shows 
what will happen if tax rates rise without any change in 
government spending.
A rise in saving will also cause GDP to fall. Indeed, a 
decision by households to save more can actually result in 
them saving less. Th
is is because higher saving can reduce 
income and hence the ability of households to save. Th
is is 
referred to as the 
paradox of thrift 
.
Inflationary and deflationary gaps
In the short run, and Keynesians argue also possibly in the 
long run, an economy may not achieve full employment. 
An 
infl ationary gap
will occur if aggregate expenditure 
exceeds the potential output of the economy. In such a 
situation, not all demand can be met, as there are not 
enough resources to do so. As a result the excess demand 
drives up the price level. 
Figure 9.22
shows that an 
economy is in equilibrium at a GDP of 
Y
, which is above 
the level of output, 
X
, that could be achieved with the full 
0
Saving and investment
Saving
Investment
GDP
Y
Figure 9.18 
Equilibrium income in a two-sector economy
0
Saving and investment
GDP
S
I
I
1
Y
Y
1