National Income and Flow-of-Funds Analysis

By John P. Powelson | Go to book overview

Chapter 8
MODELS AND MULTIPLIERS (Continued)

THE EFFECT OF LEAKAGES

In order to present the multiplier in easy doses, certain simplifications were made in the first and second models of Chapter 7 which must now be removed. The multiplier was depicted as a series of interactions between the producing and household sectors. Let us now admit the existence of the government and the rest of the world, and see how multiplier theory is revised accordingly.

Leakages are the means by which the flow of income is lost from the ever-recurrent stream. It it were not for leakages, the multiplier would be infinite, for a new injection of income would continue to flow from producers to households and back again forever. Furthermore, leakages quantify the multiplier, for the amount lost from the income stream each time it flows around is the factor determining the number of times it can flow before it has run dry.

So far, savings are the only leakage we have discussed. Others are taxes, in which income is diverted to the government, and imports, through which personal consumption expenditures become the income of foreigners instead of being perpetuated in the resident-income stream. All leakages have the possibility of being returned to the income stream. The proceeds of saving may be loaned to business enterprises (via the banks, through security purchases by households, or by other means revealed in the flow-of-funds accounts), which thus obtain the means to produce more capital goods. Taxes, income of the government, may be respent. Purchases from foreigners add to the income of the rest of the world. This is somewhat more elusive, since foreigners tend to buy products of their own nationals, and even the part of their income that spills out into imports may go to other countries instead of our own. Nevertheless, so long as foreigners' incomes are rising, it is possible that they will spend a portion of them on this country's output. Hence some of the leakage to other countries may be returned, via exports, to the domestic producing sector.

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