Scribd
Upload
91 views

Chapter 1 Circular Flow of Income

The document discusses the circular flow of income in a simple two sector economy consisting of households and firms. It explains that income flows from firms to households through factor payments, and then from households back to firms through consumption expenditures. This closed loop flow is known as the circular flow of income. In a simple two sector economy without savings, total production equals total consumption, factor payments equal factor income, and consumption expenditures equal factor income, creating equilibrium in the circular flow.

Uploaded by

Shivansh Singh
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
91 views

Chapter 1 Circular Flow of Income

The document discusses the circular flow of income in a simple two sector economy consisting of households and firms. It explains that income flows from firms to households through factor payments, and then from households back to firms through consumption expenditures. This closed loop flow is known as the circular flow of income. In a simple two sector economy without savings, total production equals total consumption, factor payments equal factor income, and consumption expenditures equal factor income, creating equilibrium in the circular flow.

Uploaded by

Shivansh Singh
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

Chapter 1 Circular flow of Income


Meaning of circular flow of income
It refers to cycle of generation of income in the production process, its distribution among the
factors of production and finally, its circulation from household to firms in the form of
consumption expenditure on goods and services produced by them.

In other words income flows first from firms to household in the form of factor –payment
and then, from household to firms in the form of consumption expenditure, this flow is
known as circular flow of income.

Phase of circular flow of income


1.) Generation phase in this face firms produce goods and services with the help of factor
services.
2.) Distribution phase in this phase involve the low of factor income from firms to household.
3.) Disposition phase in this phase the income received by factors of production is spent on
goods and services produced by firms, it means flow of money in the form of consumption
expenditure from household to firms.

Stock and flow


1.) Stock: Stock variable refers to that variable which is measured at a particular point in time.
for example, stock of goods as on 1st April 2017, national wealth, national capital, money
supply etc.
⮚ Stock does not have a time dimensional.
⮚ Stock is a static concept.
2.) Flow: Flow refers to that variable which is measured over a period of time. for example,
production of goods in January 2017, birth rate in 2017, national income.
⮚ Flow has a time dimensional as its magnitude can be measured over a period of time.
⮚ Flow is a dynamic concept.

Types of circular flow of income


1.) Real flow real flow refers to the flow of factor services from household to firms and the
corresponding flow of goods and services from firms to household.

⮚ It is also known as physical flow.


⮚ In real flow only exchange of goods and services between the two sectors without
money.

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD


SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

⮚ Real flow determines the magnitude of growth process in an economy.

3.) Money flow money flow refers to flow of factor payments from firms to household for their
factor services and corresponding flow of consumption expenditure from household to firms
for purchase of goods and services produced by firms
⮚ It is also known as nominal flow.
⮚ It involves exchange of money between the two sectors.
Difference between Stock and Flow
BASIS STOCK FLOW

Meaning Stock variable refers to that Flow variable refers to that variable, which is
variable, which is measured at a measured over a period of time.
particular point of time.
Time
It does not have a time dimension.
Dimension It has a time dimension.

Nature of It is a dynamic concept.


concept It is a static concept
Number of births during 2018, National Income,
Examples Population of India as on 31.03.17, quantity of wheat produced, Expenditure.
National wealth, Money supply,
quantity of wheat stored.

Difference between Real flow and money flow


BASIS REAL FLOW MONEY FLOW

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD


SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

Meaning It is the flow of goods and services It is the flow of money between firms
between firms and households. and households.

Kind of
exchange It involves exchange of goods and It involves exchange of money between
services. two sectors.

Difficulty
in There may be difficulties of barter There is no such difficulty in case of
exchange system money flow.

Alternative It is also known as physical flow. It is also known as Nominal flow


name

Circular flow of income in two sector economy


A simple economy assumes the existence of only two sector i.e. household sector and firm
sector and there is no government sector and foreign sector. it is also known as closed
economy.

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD


SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

Above circular flow of income can explained with the help of following points

1) Household sector supplies factor services only to firms and the firms hire factor
services only from household.
2) Firms produce goods and services and sell their entire output to the households.
3) Households receive factor income for their factor services and spend the entire
amount on consumption of goods and services.
4) There is no savings in the economy, neither the household save from their incomes,
nor the firms save from their profits.
5) This flow of income continues as a production activity due to never ending human
wants. It makes the flow of income circular.

Conclusion of circular flow in a simple economy


⮚ Total production = Total consumption
⮚ Factor payment = Factor income
⮚ Consumption expenditure = Factor income
⮚ Real flow(Inner Loop) = Money flow(Outer Loop)

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD


SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

Leakages and injections

A.) Leakages it refers to withdrawal of money from the circular flow .withdrawal of money
does not pass through the circular flow of income , it means leakages reduce the flow of
income.

Examples of leakages in different types of Economics


⮚ Two sector economy (without financial market) = No leakages
⮚ Two –sector economy (with financial market) = Savings
⮚ Three –sector economy = Savings +Taxes
⮚ Four-sector economy = Savings+ Taxes +Imports

B.) Injections: It refers to the introduction of income into the circular flow. As a result
injections increase the flow of income.

Examples of injections in different type of Economics


⮚ two –sector economy (without financial market) = No Injection
⮚ two-sector economy(with financial market) = Investment
⮚ three-sector economy = Investment +Government expenditure
⮚ four – sector economy = Investment+ Government expenses +Exports

Note It must be noted that Equilibrium is achieved when injections are equal to leakages

Note Closed economy is an economy which has no economic relations with the rest of the
world (foreign countries).

Note Open economy is an economy which has economic relations with the rest of the world.

NOTE Injections and leakages are not included in syllabus. But you can read this for
knowledge purpose.

SALWAN PUBLIC SCHOOL, TDSC, GHAZIABAD

You might also like