Cover Page

Project on: Circular Flow of Income

in All of the Economy — Leakages
and Injections
Submitted by: Mahi Choudhary
Class 12 –A
Roll Number: [Roll No.]
School Name: SDPS International
School
Academic Year: 2025–26
Submitted to: Mrs. Ritika Bhatia

.
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 Acknowledgement

I would like to express my heartfelt

gratitude to my Economics
teacher,Mrs. Ritika Bhatia Mam,
whose guidance and support made this
project possible. I would also like to
thank my school for providing the
resources, and my parents and friends
for their constant encouragement.

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 Certificate

This is to certify that [Your Name], a student of Class XII –

[Section], has successfully completed the Economics project
titled:
“Circular Flow of Income in All of the Economy: Leakages
and Injections”
under the guidance of Mrs Ritika bhatia, in partial fulfillment
of the requirement for the subject of Economics as prescribed by
the Central Board of Secondary Education (CBSE) for the
academic session 2025–26.
The project is the original work of the student and has been
completed sincerely and diligently.
<br>Signature of Student
Name: [Mahi Choudhary]
Roll No: [Your Roll Number]

<br>Signature of Teacher
Name: [Teacher’s Name]
Designation: Economics

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 Introduction
Economics, as a social science, deals with the production,
distribution, and consumption of goods and services. One of its
fundamental concepts at the macroeconomic level is the Circular
Flow of Income, which represents how money moves through an
economy.
In any economy, there are constant interactions between different
sectors—households, firms, the government, and the rest of the
world. These interactions involve the exchange of goods, services,
and payments. The Circular Flow of Income is a visual model
that explains how income circulates in an economy, showing the
relationship between producers and consumers.
This project explores this concept in depth, particularly focusing
on the roles of leakages and injections—the factors that disturb
the smooth flow of income and determine the equilibrium in an
economy. By analyzing these components, one can understand
how economies grow, shrink, or stay in balances

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 Index
1. Introduction

2. Concept of Circular Flow of Income

3. Types of Economies

4. Real and Money Flows.

5. Participants in an Economy

6. Meaning of Leakages and Injections.

7. Types of Leakages

8. Types of Injections

9. Equilibrium and Disequilibrium

10. Importance in National Income Accounting

11. Real-Life Examples (India-specific)

12. Graphs and Diagram

13. Conclusion

14. Case Studies

15.. Bibliography

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 Concept of Circular Flow of Income

The Circular Flow of Income is an economic model that

describes how money and goods move between different
sectors of an economy. It shows the movement of income,
expenditure, and output between producers and consumers
in a continuous loop.
At its core, the model is based on the principle that one
person's expenditure is another person’s income. For
example, when households spend money on goods and
services, businesses receive that as income. In turn,
businesses pay wages to workers, rent to landowners, and
profits to entrepreneurs, who are all part of the household
sector.
There are two major types of flows in this model:
1. Real Flow – This refers to the physical flow of goods and
services between sectors.
2. Money Flow – This is the monetary counterpart, i.e., the
payments for goods and services or for factors of
production.
Initially, the circular flow can be shown in a two-sector
model (households and firms), but real-world economies are
more complex. Therefore, we study a four-sector model
including:

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 ●​ Households
●​ Firms
●​ Government
●​ Foreign Sector (Rest of the World)
Each of these sectors contributes to the flow of income and
expenditure, influencing the economic cycle.

Types of Economies (Based on Circular Flow)

The Circular Flow of Income varies depending on the type
of economy. Economists use models based on the number of
sectors involved:

1. Two-Sector Economy (Simplest Model)

Participants: Households and Firms

●​ Households provide factors of production (land, labor,
capital) to firms.
●​ Firms provide goods and services in return.
●​ Income flows from firms to households (wages, rent,
interest, profit), and expenditure flows from
households to firms (consumption).

Assumption: No government or foreign trade. All income is

spent.
2. Three-Sector Economy

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 Participants: Households, Firms, and Government
●​ Government collects taxes (leakage) and spends on
public goods and services (injection).
●​ This model reflects a more realistic economy where
fiscal policy influences flow.

3. Four-Sector Economy

Participants: Households, Firms, Government, and Foreign

Sector.
●​ Foreign trade introduces exports (injection) and
imports (leakage).
●​ This is the most comprehensive model used in open
economies like India.

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 Real and Money Flows
In a circular economy model, two types of flows occur
simultaneously:

1. Real Flow
Movement of actual goods and services.
Example: Labor provided by households, goods produced by
firms.

2. Money Flow
Movement of monetary payments for goods and services or
factor inputs.
Example: Wages paid to households, revenue received by
firms.
These two flows operate in opposite directions and are
interdependent. Without real flows, money flows cannot
exist, and vice versa.

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 Participants in an Economy
In a four-sector model, the following economic agents
participate in the circular flow:

1. Households
●​ Provide factors of production (land, labor, capital,
entrepreneurship).
●​ Receive income in the form of wages, rent, interest,
and profit.
●​ Spend income on consumption of goods and services.

2. Firms
●​ Produce goods and services.
●​ Hire factors of production from households and pay
them.
●​ Sell output to households, government, and foreign
buyers.

3. Government
●​ Collects taxes from households and firms (leakage).
●​ Spends on infrastructure, education, defense, subsidies,
etc. (injection).
●​ Influences flow via fiscal policy (taxation and
spending).

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4. Foreign Sector
●​ Represents trade with the rest of the world.
●​ Exports bring money into the economy (injection).
●​ Imports send money out of the economy (leakage).

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 Meaning of Leakages and Injections

The circular flow of income does not always remain

constant. Certain activities cause money to leave or enter
the flow:
Leakages
These are withdrawals from the income flow that reduce
the circular movement of money.

Examples:
●​ Savings (S): Income not spent on consumption.
●​ Taxes (T): Paid to the government, not directly spent.
●​ Imports (M): Spending on foreign goods/services.

Injections
These are additions to the flow of income, increasing
economic activity.

Examples:
●​ Investment (I): Business spending on capital goods.
●​ Government Expenditure (G): Public spending on
goods/services.
●​ Exports (X): Foreign spending on domestic
goods/services.

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 The overall flow is in equilibrium when:
Total Leakages = Total Injections
i.e., S + T + M = I + G + X

Types of Leakages in the Circular Flow

Leakages are withdrawals from the flow of income which
reduce the amount of money circulating in the economy. If
leakages increase without matching injections, the economy
may contract.

1. Savings (S)
●​ Income that households do not spend on consumption.
●​ Saved in banks or other financial institutions.
●​ While savings reduce immediate consumption, they can
be redirected as investment later.
●​ Example: A household earning ₹50,000 saves ₹10,000
instead of spending it. That ₹10,000 is a leakage.

2. Taxes (T)
●​ Compulsory payments to the government by
households and firms.
●​ Reduces disposable income and consumption
expenditure.

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 ●​ However, the government may reinject this money
through public spending.
●​ Example: If you earn ₹1,00,000 and pay ₹20,000 in
taxes, your consumption potential falls—causing a
leakage.

3. Imports (M)
●​ Spending on foreign goods and services.
●​ Money leaves the domestic economy and flows to other
countries.
●​ Example: Buying an iPhone imported from the U.S.
means your money goes abroad, reducing domestic
income flow.

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 Types of Injections in the Circular Flow

Injections are additions to the flow of income and help

expand economic activity. They help counter the effects of
leakages.

1. Investment (I)
●​ Expenditure by businesses on capital goods (machinery,
buildings, etc.)
●​ Stimulates production and employment.
●​ Example: A company investing ₹1 crore in a new
factory injects money into the economy by hiring labor,
buying raw materials, etc.

2. Government
Expenditure (G)
●​ Spending by the government on infrastructure,
education, defense, subsidies, etc.
●​ Increases demand and boosts income for various
sectors.
●​ Example: Road construction creates jobs and demand
for materials, injecting funds into multiple industries.

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3. Exports (X)
●​ Goods and services sold to foreign buyers.
●​ Brings foreign currency into the country.
●​ Example: An Indian textile firm exports garments to
Europe and earns foreign exchange, adding to domestic
income.

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 Equilibrium and Disequilibrium in the
Circular Flow

●​ Equilibrium in Circular Flow

●​ An economy is said to be in equilibrium when total

leakages = total injections.

●​ Mathematically,
S+T+M=I+G+X

●​ Savings (S), Taxes (T), and Imports (M) are

withdrawals.

●​ Investment (I), Government Spending (G), and Exports

(X) are injections.

In equilibrium, the total output produced by firms is

completely purchased, and there is no unplanned change in
inventories.

Disequilibrium in Circular Flow

Occurs when leakages ≠ injections. This causes:
●​ Surplus or shortage in output

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 ●​ Inflation or deflation

●​ Unemployment or overproduction

Example:
●​ If leakages exceed injections, the economy contracts
(recession).

●​ If injections exceed leakages, the economy expands

(possibly inflation).

●​ Understanding this helps policymakers use fiscal tools

(taxes, spending) and monetary tools (interest rates) to
stabilize the economy.

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 Importance of Circular Flow Analysis

Understanding the circular flow helps in:

1. National Income Accounting

Assists in calculating GDP through income, expenditure, or
production approach.

2. Understanding Economic Structure

Shows the relationship between sectors and flow of
resources.
3. Policy Making
Helps governments plan taxation, investment, and spending
policies.
4. Business Decision Making
Firms forecast demand, production, and capital needs based
on flow behavior.
5. Identifying Leakages and Imbalances
Guides necessary injections to maintain growth and avoid
inflation or stagnation.

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 Real-Life Examples from India (2024–25)

1. Government Expenditure as an Injection

In the Union Budget 2024–25, the Indian government

announced significant investments in infrastructure,
healthcare, and education sectors. These expenditures are
injections into the economy, stimulating demand and
promoting economic growth. Such government spending
increases the flow of income by creating jobs and enhancing
public services.

2. Taxation as a Leakage

The same budget introduced revised income tax slabs

under the new tax regime, aiming to provide relief to
taxpayers. While taxation is a leakage from the circular
flow, as it reduces disposable income, the government's
strategy to adjust tax rates seeks to balance revenue
collection with consumer spending power.

3. Trade Dynamics: Exports and Imports

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In April 2025, India's merchandise exports reached $38.5
billion, marking a 9.1% year-on-year increase. However,
imports surged by 19% to $64.9 billion, leading to a trade
deficit of $26.4 billion—the highest since November of the
previous year. Exports serve as injections, bringing income
into the economy, while imports are leakages, as they
represent spending on foreign-produced goods and services.

4. Foreign Direct Investment (FDI) as an Injection

India witnessed a revival in FDI inflows, with a 17.9%

year-on-year growth, reaching $55.6 billion in the first
eight months of FY25. FDI acts as an injection by bringing
foreign capital into the economy, fostering business
expansion, and generating employment opportunities.

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 Visual Representation of Leakages and
Injections

To enhance understanding, include a diagram illustrating

the circular flow of income with labeled leakages (savings,
taxes, imports) and injections (investment, government
spending, exports). This visual aid will help in
comprehending how different economic activities influence
the overall income flow.

Note: Since I cannot create images directly, you can refer to

educational resources or textbooks for diagrams
representing the four-sector circular flow model.

Summary Table – Leakages and Injections

Financial sector Savings (S) Investment (I)

Govt sector Taxes (T) Govt.spending (G)
Foreign sector Imports (M) Exports (X)

Equilibrium Condition: To maintain a stable economy, the

total leakages should equal total injections: S + T + M = I +
G+X

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 Conclusion

The circular flow of income model provides a

comprehensive framework to understand the functioning of
an economy. It illustrates the continuous movement of
money, goods, and services among different sectors.
Leakages and injections play a crucial role in influencing the
level of economic activity. By analyzing these components,
policymakers can implement strategies to achieve economic
stability and growth.

Graphs and Diagrams

1. Basic Two-Sector Circular Flow of Income Diagram

Sectors involved: Households and Firms

Flows shown:

Real flow: Factors of production → Goods and services

Money flow: Wages, rent, profit → Consumption

expenditure

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(Insert Diagram titled: "Two-Sector Circular Flow")

---

2. Three-Sector Circular Flow (Inclusion of Government)

Sectors involved: Households, Firms, and Government

Additional flows:

Taxes (T) → Government

Government Expenditure (G) → Firms and Households

(Insert Diagram titled: "Three-Sector Circular Flow with

Government")

---

3. Four-Sector Circular Flow Model

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Adds the Foreign Sector to the model

Injections: Exports (X), Government Spending (G),

Investment (I)

Leakages: Imports (M), Savings (S), Taxes (T)

(Insert Diagram titled: "Four-Sector Circular Flow with

Foreign Trade")

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 Case Study 1 – MGNREGA as an Injection
in Rural India

●​Background:The Mahatma Gandhi National Rural

Employment Guarantee Act (MGNREGA) provides
100 days of guaranteed wage employment to rural
households in India.

●​Injection:
The government spends thousands of crores annually under
this scheme.

These funds act as government expenditure (G), injecting

money into rural areas.

●​Impact on Circular Flow:

Workers receive wages → Increased consumption.

Local businesses see higher demand → More production

and employment.

This cycle increases income flow and supports rural

economies.

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 ●​Data Point:
In 2023–24, over ₹90,000 crore was allocated to
MGNREGA, reaching ~10 crore households.

Case Study 2 – India's Oil Imports as a

Leakage

●​Background:
India imports over 80% of its crude oil, making it one of the
top oil-importing countries.

●​Leakage:
Payments made in foreign currency for imports flow out of
the domestic economy.

This represents a leakage (M) in the circular flow.

●​Impact on Circular Flow:

Money spent on oil doesn’t circulate domestically.

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Leads to trade deficits and reduces national income unless
balanced by exports or other injections.

●​Data Point:
In FY24, India’s crude oil import bill crossed $170 billion,
widening the current account deficit.

Case Study 3 – FDI in India as a Key

Injection

●​Background:
Foreign Direct Investment (FDI) involves foreign companies
investing in Indian businesses, infrastructure, and
industries. India has become a major FDI destination due to
its large market, young workforce, and improving business
environment.

●​Injection:
FDI brings foreign capital, technology, and employment
into the economy.

It is a direct injection (I) in the circular flow, boosting

production, income, and consumer demand.

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 ●​ Example:
Companies like Amazon, Apple, and Samsung have heavily
invested in Indian manufacturing and retail.

In 2024, Apple began iPhone manufacturing in India,

creating thousands of jobs and building a local supplier
ecosystem.

●​Impact on Circular Flow:

Local employees earn wages (household income).

Domestic suppliers gain business.

Government collects taxes and boosts infrastructure.

Consumer demand rises with new jobs and income.

●​Data Point:
In the first eight months of FY25, India received $55.6
billion in FDI, a 17.9% increase from the previous year.

Case Study 4 – GST: A Dual Role in India’s

Circular Flow
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 ●​ Background:The Goods and Services Tax (GST) is a
unified indirect tax system implemented in India 2017.
It replaced multiple state and central taxes,
streamlining the tax structure.
GST as a Leakage
GST is a tax collected by the government on the sale of
goods and services.
When consumers and businesses pay GST, it is a withdrawal
(T) from their income/spending.
This acts as a leakage from the circular flow of income.

●​ Example:
If you buy a product for ₹1,000, and GST is ₹180, that
₹180 goes to the government and not directly back into
business or household consumption.

GST as an Injection
The government uses GST collections to fund
infrastructure, education, subsidies, and public services.
These expenditures are government injections (G) into the
economy.

●​Example:

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GST collected from businesses may be spent on building
roads, hospitals, or providing subsidies, which re-injects.

Case Study 5 – Circular Flow of Income in a

Four-Sector Economy (Sandeep Garg
Reference)

●​ Background (from Sandeep Garg’s Explanation):

Sandeep Garg emphasizes the four-sector model of the
economy involving:
●​ Households
●​ Firms
●​ Government
●​ Foreign Sector

This model illustrates how income flows through different

sectors, and how leakages and injections affect national
income.

Case Study: Impact of Export Promotion

Scheme by Government

●​ Scenario:

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The government introduces an Export Promotion Scheme,
offering subsidies and tax rebates to textile exporters.

Circular Flow Breakdown:

1.​Firms increase production due to higher demand from
foreign markets.
2.​Households earn more wages as employment in the
textile sector rises.
3.​Government spends money on incentives—an injection
(G).
4.​Foreign Sector brings in money through exports
(X)—another injection.
5.​Increased household income leads to higher
consumption, fueling the circular flow.
6.​Real-World Example Inspired by the Text:
7.​In 2022, the Indian government’s RoSCTL scheme
(Rebate of State and Central Taxes and Levies)
promoted textile exports, contributing to a surge in
garment exports from Tirupur and Surat.

Conclusion (Aligned with Sandeep Garg):

This example clearly shows how government spending and
foreign demand work as injections, boosting the circular
flow and increasing national income—just as illustrated in
Sandeep Garg’s four-sector model diagrams.

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 Bibliography

1. NCERT Economics Textbook – Class 12 (Part A)

National Council of Educational Research and Training
(NCERT)
https://ncert.nic.in
2. Sandeep Garg – Introductory Macroeconomics Class 12
Dhanpat Rai Publications
3. Investopedia – Circular Flow of Income
https://www.investopedia.com/terms/c/circular-flow-of-inc
ome.asp
4. GeeksforGeeks – Circular Flow of Income in Economics
https://www.geeksforgeeks.org/circular-flow-of-income/
5. Wikipedia – Circular Flow of Income
https://en.wikipedia.org/wiki/Circular_flow_of_income
6. Government of India – Ministry of Finance & NITI
Aayog Reports
https://www.finmin.nic.in
https://www.niti.gov.in
7. Press Information Bureau (PIB) – Official Data on FDI,
MGNREGA, and GST
https://www.pib.gov.in

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