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    Circular Flow of Income

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    Sakksham Behl
    The document discusses the circular flow of income model which describes the reciprocal circulation of income between producers (firms) and consumers (households). Firms provide goods and services in exchange for consumer expenditure and factors of production from households like labor, capital, and land. Households use their income to purchase goods and services from firms, completing the circular flow. The model can be expanded to three sectors including government, four sectors adding the rest of the world, or five sectors fully integrating savings, taxes, imports, investment, government spending, and exports. The circular flow model demonstrates the interdependence between economic entities and is useful for measuring and understanding national income.

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    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd

    Circular Flow of Income

    Uploaded by

    Sakksham Behl
    310 views15 pages
    The document discusses the circular flow of income model which describes the reciprocal circulation of income between producers (firms) and consumers (households). Firms provide goods and services in exchange for consumer expenditure and factors of production from households like labor, capital, and land. Households use their income to purchase goods and services from firms, completing the circular flow. The model can be expanded to three sectors including government, four sectors adding the rest of the world, or five sectors fully integrating savings, taxes, imports, investment, government spending, and exports. The circular flow model demonstrates the interdependence between economic entities and is useful for measuring and understanding national income.

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    The document discusses the circular flow of income model which describes the reciprocal circulation of income between producers (firms) and consumers (households). Firms provide goods and services in exchange for consumer expenditure and factors of production from households like labor, capital, and land. Households use their income to purchase goods and services from firms, completing the circular flow. The model can be expanded to three sectors including government, four sectors adding the rest of the world, or five sectors fully integrating savings, taxes, imports, investment, government spending, and exports. The circular flow model demonstrates the interdependence between economic entities and is useful for measuring and understanding national income.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    310 views15 pages

    Circular Flow of Income

    Uploaded by

    Sakksham Behl
    The document discusses the circular flow of income model which describes the reciprocal circulation of income between producers (firms) and consumers (households). Firms provide goods and services in exchange for consumer expenditure and factors of production from households like labor, capital, and land. Households use their income to purchase goods and services from firms, completing the circular flow. The model can be expanded to three sectors including government, four sectors adding the rest of the world, or five sectors fully integrating savings, taxes, imports, investment, government spending, and exports. The circular flow model demonstrates the interdependence between economic entities and is useful for measuring and understanding national income.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 15

    Circular flow of income

    By: Anuj Aggarwal

    Circular flow of income or


    circular flow
    Refers to a simple economic model which
    describes the reciprocal circulation of income
    between producers and consumers.
    In the circular flow model, the interdependent entities of producer and consumer
    are referred to as "firms" and "households"
    respectively and provide each other with
    factors in order to facilitate the flow of income.

    Firms and Households

    Provide consumers with goods and services in exchange


    for consumer expenditure and "factors of production"
    from households.

    In this process, household sector provides various factors


    of production such as land, labor, capital and enterprise to
    producers who produce goods and services by
    coordinating them. Producers or business sector in return
    makes payments in the form of rent, wages, interest and
    part of profits to the household sector.

    Household sector spends this income to fulfill its wants in


    the form of consumption expenditure. Business sector
    supplies those goods and services produced and get
    income in return of it.

    Two Sector Model

    In the simple two sector circular flow of income


    model the state of equilibrium is defined as a situation
    in which there is no tendency for the levels of income
    (Y), expenditure (E) and output (O) to change,
    Y=E=O

    This means that the expenditure of buyers


    (households) becomes income for sellers (firms). The
    firms then spend this income on factors of production
    such as
    labour, capital and
    raw materials,
    "transferring" their income to the factor owners. The
    factor owners spend this income on goods which leads
    to a circular flow of income.

    Two-Sector Economy
    (When All Income is Consumed)
    Wages and
    Profits (i.e.
    income (Y)
    Rs.1000

    Productive
    Sector

    Household
    Sector

    AtEquilibrium :
    Y AD
    AD C
    Y C

    Private
    Consumption (C)
    Rs.1000

    Three Sector Model

    It includes household sector, producing sector and


    government sector. It studies a circular flow income in
    these sectors excluding rest of the world i.e. closed
    economy income.

    The income received from the government sector flows to


    producing and household sector in the form of payments
    for government purchases of goods and services as well
    as payment of subsides and transfer payments.

    Every payment has a receipt in response of it by which


    aggregate expenditure of an economy becomes identical
    to aggregate income and makes this circular flow
    unending.

    Closed Economy
    Wages and
    Profits (i.e.
    income (Y)
    Rs.1000

    AtEquilibrium :
    Household
    Sector

    Productive
    Sector

    Y AD
    AD C S C I
    InEquilibrium
    SI

    Private
    Consumption
    (C) Rs.800
    Investment
    Rs.200

    Savings (S)
    Rs.200
    7

    Four Sector Model

    A modern monetary economy comprises a network of


    four sector economies this are:
    1.Household sector
    2.Firms or producing sector
    3.Government sector
    4.Rest of the world sector.

    Each of the above sectors receives some payments


    from the other in lieu of goods and services which
    makes a regular flow of goods and physical services.

    A residual of each market comes in capital market as


    saving which in turn is invested in firms and
    government sector.

    Circular Flow of Income


    Y=C+I+G+X-M

    Five sector model


    In

    terms of the five sector circular


    flow of income model the state of
    equilibrium occurs when the total
    leakages are equal to the total
    injections that occur in the economy.
    This can be shown as:
    Savings + Taxes + Imports = Investment
    + Government Spending + Exports
    S + T + M = I + G + X.

    Five sector model

    Therefore since the leakages are equal to


    the injections, the economy is in a stable
    state of equilibrium. This state can be
    contrasted to the state of disequilibrium
    where the sum of total leakages does not
    equal the sum of total injections.

    Disequilibrium can be shown as:


    S+T+MI+G+X

    Significance of Study of
    Circular Flow of Income
    1.Measurement of National Income- National
    income is an estimation of aggregation of
    economic activity. It is either the income of all
    the factors of production or the expenditure of
    various sectors of economy.
    2.Knowledge of Interdependence- Circular flow of
    income signifies the interdependence of each
    activity upon one another. If there is no
    consumption, there will be no demand and
    expenditure which restricts the amount of
    production and income.

    Difference between Real


    Flow and Money Flow

    Real flow is the exchange of goods and services


    between households and firms whereas money
    flow is the monetary exchange between two
    sectors.

    In real flow, household sector supplies raw


    material, land, labour, capital and enterprise to
    firms and in return business sector provides
    finished goods and services to household sector.
    Whereas in money flow, firm sector gives
    remuneration in the form of money to household
    sector via wages and salaries, interest etc.

    Thankyou

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