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Circular Flow of Income

The circular flow of income model describes the reciprocal circulation of income between producers and consumers. In this simplified model, firms provide goods and services to households in exchange for consumer expenditure and factors of production. Households then use their income to purchase goods and services from firms. The model assumes a closed economy with two sectors - households and firms - and that households spend all their income on consumption with no saving.

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54 views3 pages

Circular Flow of Income

The circular flow of income model describes the reciprocal circulation of income between producers and consumers. In this simplified model, firms provide goods and services to households in exchange for consumer expenditure and factors of production. Households then use their income to purchase goods and services from firms. The model assumes a closed economy with two sectors - households and firms - and that households spend all their income on consumption with no saving.

Uploaded by

Princez Linxy Taylor
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Circular flow of income

From Wikipedia, the free encyclopedia


This article may need to be wikified to meet Wikipedia's quality standards.
Please help by adding relevant internal links, or by improving the article's layout. (June 2010)

In this simplified image, the relationship between the decision-makers in the circular flow model is shown. Larger arrows
show primary factors, whilst the red smaller arrows show subsequent or secondary factors.

In economics, the terms circular flow of income or circular flow refer to a simple economic model


which describes the reciprocal circulation of income between producers and consumers. [1][2] In the circular
flow model, the inter-dependent 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 [1].
Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of
production" from households. More complete and realistic circular flow models are more complex. They
would explicitly include the roles of government and financial markets, along with imports and export s.

Contents
 [hide]

1 Assumptions

2 Two Sector

Model

3 Four sector

model

4 References

5 Further

reading

6 See also
Assumptions

The basic circular flow of income model consists of seven assumptions:

The economy consists of two sectors: households and firms.


1.
2. Households spend all of their income (Y) on goods and
services or consumption (C). There is no saving (S).
3. All output (O) produced by firms is purchased by households through
their expenditure (E).
4. There is no financial sector.
5. There is no government sector.
6. There is no overseas sector.
7. It is a closed economy with no exports or imports.
Two Sector Model
This section does not cite any references or sources.
Please help improve this article by adding citations to reliable sources. Unsourced material may
be challenged andremoved. (September 2009)

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, that is:

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.

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