Cambridge International as and a level Economics Ebook

Figure 9.13 
The eff ect of increasing aggregate demand
244
Cambridge International A Level Economics

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The circular flow of income
The distinction between an open and a 
closed economy
An 
open economy
is an economy that engages in 
international trade. In contrast, a 
closed economy
is one 
that does not export or import goods and services. Of 
course, no economy is a totally closed economy but such an 
economy can be used in a model of how an economy works.
Open economy: 
an economy that is involved in trade with 
other economies.
Closed economy: 
an economy that does not trade with 
other economies.
KEY TERMS
The circular flow in a closed economy and 
open economy
Th
e
 circular fl ow of income
shows how income and 
spending move around an economy. 
Figure 9.14
shows 
the process in a closed economy. Th
e inner circle shows 
the real fl ow of products and factor services and the outer 
circle the money fl ow of spending and incomes.
Circular flow of income: 
a simple model of the process by 
which income flows around the economy.
KEY TERM
In practice, there are leakages out of the circular fl ow – 
some income is saved, some is taxed and some is spent 
on imports. Some expenditure is also additional to 
the spending that comes from the incomes generated 
by domestic output. Th
ese extra items of spending, 
known as injections, are investment, government 
spending and spending by foreigners on a country’s 
exports. 
Figure 9.15
 includes these leakages, also 
known as withdrawals, in a circular fl ow of income in 
an open economy.