Why does investment spending not equal spending in the circular flow?  

1 Answer | Add Yours

pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

Investment spending does not equal spending in the circular flow model because there are other kinds of spending going on.  There are other things that households have to do with their money other than invest it.

In the simple circular flow model, households get income from businesses.  They then spend all of that income buying goods and services from the businesses.  However, we know that this is not true.  The households actually do other things such as saving their money.  When they save their money, it goes to businesses, which use it for investment purposes. 

However, this investment spending is not the same thing as all spending.  Consumers still have to engage in consumption.  They must still buy goods and services from the businesses.  In addition, there will be other things that consumers need to do such as paying taxes to the government.  This means that consumers will spend some of their money on goods and services, some on taxes, and will save some of it.  Therefore, not all spending will be investment spending in the circular flow model.

We’ve answered 319,647 questions. We can answer yours, too.

Ask a question