Why is savings regarded as a leakage from the circular flow?

Question: Why is savings regarded as a leakage from the circular flow?

In economics, the circular flow model is a simplified representation of how money and goods flow between households and firms in an economy. Households provide factors of production, such as labor and capital, to firms, and receive income in return. Firms use these factors to produce goods and services, and sell them to households, generating revenue. In a closed economy, without any government or foreign sector, the income of households should equal the revenue of firms, and the circular flow should be balanced.

However, in reality, there are some factors that cause the circular flow to be unbalanced, or leak out of the system. One of these factors is savings. Savings are a part of household income that is not spent on consumption, but rather stored for future use. Savings can be held in various forms, such as bank deposits, bonds, stocks, or physical assets. Savings are regarded as a leakage from the circular flow because they reduce the amount of money that households spend on goods and services from firms. This means that firms will have less revenue, and therefore less income to pay to households for their factors of production. This will cause the circular flow to shrink over time, unless there is an injection of money into the system from another source.

Savings are not necessarily bad for the economy, as they can provide funds for investment, which can increase the productive capacity and growth potential of the economy. However, if savings are too high relative to investment, then the circular flow will be negatively affected, and the economy may experience a recession. Therefore, it is important to maintain a balance between savings and investment in an economy, as well as between consumption and production.

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