Imagine a big circle where money keeps moving around. 👇
Households (🏠) give labour to Firms (🏭) and receive wages (💰).
Firms use those wages to buy goods and services from households and pay profits back to them.
The circle continues with the Government (🏛️) collecting taxes and spending on public goods, and the Foreign Sector (🌍) buying and selling with the rest of the world.
Every arrow in this circle is a flow of money or goods – the circular flow of income.
| Sector | What They Provide | What They Receive |
|---|---|---|
| Households | Labour & Consumption | Wages, Profits, Taxes |
| Firms | Goods & Services | Wages, Raw Materials, Capital |
| Government | Public Goods & Services | Taxes, Subsidies, Transfers |
| Foreign Sector | Exports | Imports, Foreign Investment |
Autonomous Investment (🔧) is the part of investment that happens regardless of current income levels. Think of it as a new gadget that a company buys because it’s the latest tech, not because people are buying more stuff right now.
Induced Investment (📈) rises when households earn more money and want to spend more on new things, like a family buying a bigger house when their salaries increase.
Formula: \$I = Ia + Ii\$ where \$Ia\$ = autonomous and \$Ii\$ = induced.
The accelerator says that investment is driven by the change in output (ΔY), not just the level of output.
Analogy: Imagine a factory that builds cars. If the demand for cars suddenly jumps, the factory ramps up production quickly – it “accelerates” to meet the new demand.
Mathematical form: \$I = a + b\,\Delta Y\$
where:
If \$b\$ is high, even a small rise in \$Y\$ can cause a big jump in \$I\$.