National Income
Senior 5 · Economics
National Income
Lesson 3 of 5
40 min
A worker at a tea factory in Nyamasheke is paid her wages. She spends part of them on rice and soap at a shop, which pays its supplier, which pays its drivers, who buy food from farmers, who pay school fees... The same franc becomes income for one person after another. Some of it drops out along the way: a little is saved in a SACCO, some goes to the government as tax, and part of the price of the soap pays a factory abroad. Meanwhile new spending flows in from outside: a firm borrows to build a warehouse, the government pays for a road, a buyer in Mombasa orders tea. The circular flow of income is the model that tracks these movements.
Definition
Circular flow of income: a model of the economy showing how money and real resources flow between its sectors, so that spending by one sector becomes income for another.
Real flow: the movement of goods, services and factor services. Money flow: the payments made for them, in the opposite direction.
Assume an economy with only households and firms, no government, no foreign trade, and no saving: households spend all their income on goods made by firms, and firms pay out all their revenue as factor incomes.
In this model the flow never shrinks or grows. Firms' revenue equals households' spending equals households' income, which is why output, income and expenditure (Lesson 1) must be equal: .
Real economies have three more sectors, and each opens a route out of the flow and a route back in.
Definition
Withdrawal (leakage): income that is not passed on as spending on domestic output. The three withdrawals are saving (S), taxes (T) and imports (M).
Injection: spending on domestic output that does not come from households' current income. The three injections are investment (I), government spending (G) and exports (X).
| Sector | Withdrawal from the flow | Injection into the flow |
|---|---|---|
| Financial sector (banks, SACCOs, insurance) | Saving (S): income households do not spend | Investment (I): firms' spending on capital goods and stocks, often financed by loans |
| Government | Taxes (T): income tax, VAT, excise duties | Government spending (G): salaries of teachers and nurses, roads, equipment |
| Rest of the world | Imports (M): spending on goods produced abroad | Exports (X): foreign spending on Rwandan goods and services, such as tea, coffee, minerals and tourism |
National income is stable when what leaks out is exactly replaced by what is injected:
Income keeps changing until withdrawals, which rise and fall with income, again equal injections. Lesson 4 draws this on a diagram, and Unit 3 shows why a change in injections changes income by a multiple of itself.
Worked example 1: which way will income move?
In a year (illustrative, Frw billion): saving 2,000, taxes 1,500, imports 3,000; investment 2,500, government spending 1,800, exports 2,000.
Since by 200, more is leaving the flow than entering it. Firms find sales falling; national income will fall until withdrawals have fallen by enough to equal injections.
Worked example 2: Rwanda's saving gap in 2025
Putting the injections and withdrawals side by side gives an identity that always holds in the accounts:
NISR's accounts for 2025 combine private and government saving into gross national saving, Frw 5,395 billion, and record gross capital formation (investment) of Frw 7,981 billion.
NISR's table shows exactly this figure as "net lending to the rest of the world": −2,586. Rwanda invested about Frw 2.6 trillion more than it saved, and the difference was financed from abroad, by loans, grants and foreign investment. In circular-flow terms, the injection of investment was far larger than the leakage of saving, and the gap was matched by a large leakage through imports.
Warning
Saving is not "money lost". Saving is a withdrawal only from the flow of spending on goods. If banks lend it to firms that invest, it returns to the flow as an injection. Trouble comes only when planned saving and planned investment differ, because savers and investors are different people with different motives.
Important
Discuss. Rwanda's imports were worth Frw 8,213 billion in 2025, against exports of Frw 5,041 billion (NISR). Using the circular flow, explain what this large leakage means for Rwandan firms' sales. Why might it still be good for the economy if many of the imports are machines and building materials?
EconplusDal, "Circular Flow of Income and Measures of GDP" (about 9 minutes). Watch how he adds the three withdrawals and three injections, and check that his labels match the four-sector diagram above.
Practice
Sources and credits
Written by Ganzaa: the text, both diagrams, the table, the worked examples and the practice items. Worked example 1 and the practice figures are illustrative.
