MEANING OF CIRCULAR FLOW OF INCOME eam It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them. Phases of Circular Flow of Income Generation Phase/Production Phases - In this phases, firms produce goods and services with the help of factor services. Distribution Phase/Income Phase - This phase involves the flow of factor income (rent, wages, interest and profit) Created with from firms to the households. NotewiseDisposition Phase/Expenditure Phase - In this phase, the income received by factors of production, is spent on the goods and services produced by firms. STOCK AND FLOW came Stock The stock variable refers to that variable, which is measured at a particular point of time. For example - stock of goods in godown as on 31st January, 2022. It means, stock variables are not time dimensional. National wealth, national capital, money supply etc. Flow The flow variable refers to that variable, which is measured over a period @ timeyiceFor example - production of goods during the month of January 2022, birth rate in the year 2021 are flow variable. the 'period of time’ could be a day, a week, a month, a year, etc. Difference Between Stock And Flow Basis Stock Flow Meaning Stock variable Flow variable refers to that refers to that variable, which variable, which is measured at is measured a particular over a period point of time. of time. Time It does not It has a time dimension have a time dimension as dimension. its magnitude can be measured over a period of time. Nature of It is a static It is a dynamic concept concept. concept. Created with NotewiseTYPES OF CIRCULAR Real Flow (Physical Flow) Real flow refers to the flow of factor services from households to firms and the corresponding flow of goods and services from firms to households. Factor Services (Land, Labour, Capital & Enterprise) oa Goods and Services Money Flow (Nominal Flow) Money Flow refers to flow of factor payments from firms to households for their factor services and corresponding flow of consumption expenditure from households to firms for purchas¢pt. en Notewisegoods and services produced by the Consumption Expenditure (On Goods and Services) firms. Factor Payments (Rent, Wages, Interest & Profit) Difference Between Real Flow And Money Flow Basis Real Flow | Money Flow Meaning It is the flow of | Itis the flow of goods and money services between firms between firms and and households. households. Kind of It involves It involves exchange exchange of exchange of goods and money services cumin @ NiotewiseDifficulty in There may be There is no exchange difficulties in such difficulty the barter in the case of system in money flow. exchange of goods and services. Alternative Itis also known | Itis also known name as Physical as Nominal Flow. Flow. Four Sector of the Economy Household Sector - It includes consumers of goods and services and also the owners of factors of production. They supply factors like land, labour, capital and entrepreneur and receive income in return in the form of rent, wages, interest and profit respectively. Created with NotewiseProducing Sector (Firm) - It includes all producing firms in the economy. To produce goods and services, the firm hires factors of production from the households. Households consume goods and services to satisfy their wants and firms produce goods and services to make a profit. Government Sector - It acts in two capacities: - As a welfare agency, it is involved in maintaining law and order, defence and other services of public welfare. « As a producer, it produces goods and services in public sector enterprises. Created with NotewiseForeign Sector (or External Sector or Rest of the World Sector) - This sector includes transactions with the rest of the world. It is involved in export and import of goods and flow of capital between the domestic economy and other countries of the world. CIRCULAR FLOW INA SIMPLE ECONOMY (TWO-SECTOR ECONOM Y ) can 1. There are only 2 sectors in the economy: Household and Firms. 2. Household sector supplies factor services only to firms and the firms hire factor services only from households. Created with Notewise3. Firms produce goods and services and sell their entire output to the households. 4. Households receive factor income for their services and spend the entire amount on consumption of goods and services. 5. There are no savings in the economy, i.e. neither the households save from their incomes, nor the firms save from their profits. 6. It is also known as circular flow in a two sector economy (without financial market). Factor Services cg savent abled anc ue sumption Expeneia,. Ure Pen 60048 and Servjea <> Factor Payments ne i eeeyey a Vages, Interest 0 jOods and Service® > Created with NotewiseCIRCULAR FLOW INA TWO-SECTOR (WITH FINANCIAL MARKET )commnnnmm In a two sector economy with a financial market, households do not spend their entire income on consumption, i.e., a part of their income is saved. Similarly, firms also save some part of their receipts for expansion or other reasons. Firms also borrow money to finance their expansion programmes. a nd es, interest a0 Goods and service’ ‘ent, WagThe financial market refers to institutions such as banks, insurance companies etc., which transact loanable funds. CIRCULAR FLOW INA THREE-SECTOR ECONOMY eau 1. There are 3 sectors in the economy: Households, Firms and The government sector. 2. Money flows from the government to households in the form of: i) Transfer payments like scholarships, old age pension, etc. ii) Factor payments for hiring factor services of households. 3. Money flows back to the government from households in the form of direct taxes like income tax, interest ta@eteewise4.Money flows from firms in the form of direct taxes and indirect taxes. 5. Money flows to the firms from the government, when the latter grants subsidies and makes payment to the former for purchase of goods and services produced by the firms. 6. A part of the income earned by the government is also saved and deposited in the financial market. The government also borrows money from the financial market to meet its expenditureRole of Government Sector in an Economy Government Sector performs the following activities in the economy: (a) The Government collects taxes from households and firms. (b) The government makes transfer payments to the households and provides subsidies to the firms. (c) The government makes the payment for purchase of goods and services from the firms. (d) The government saves and borrows money with the help of the financial market. rset with @ NotewiseCIRCULAR FLOW INA FOUR-SECTOR ECONOMY eau 1. There are 4 sectors in the economy: Households, Firms, Government and Foreign sectors. 2. Households provide factor services to firms, government and foreign sectors. In return, it receives factor payments. Households also receive transfer payments from the government and the foreign sector. Households spend their income on: (i) Payment for goods and services purchased from firms; (ii) Tax payments to government; (iii) Payments for imports. O itvivivise3. Firms receive revenue from households, government and the foreign sector for sale of their goods and services. Firms also receive subsidies from the government. Firm makes payments for: (i) Factor services to households (ii) Taxes to the government (iii) Imports to the foreign sector. 4. The government receives revenue from firms, households and the foreign sector for sale of goods and services, taxes, fees, etc. The government makes factor payments to households and also spends money on transfer payments and subsidies. Created with Notewise5. Foreign sector receives revenue from firms, households and government for export of goods and services. It makes payments for import of goods and services from firms and the government. It also makes payment for the factor services to the households. Consumption Expendi3s> Significance of Circular Flow of Income 1. It helps us to understand the mutual interdependence among different sectors of the economy namely O was Notewisehousehold sector, producer sector, government sector and foreign sector. It shows that all the sectors are complementary to one another in such a way that the economic activity remains intact. 2. It shows the equilibrium position of the economy. If there is any distortion in the circular flow, the economy will be in disequilibrium and the smooth functioning of the economy will be disturbed. 3. It helps in identifying various types of leakages and injections in the economy. 4. It helps in estimation of national income. Circular flow shows the three phases of flow of income (generation, distribution and disposition). It facilitates determination of three different ways Notewise(production, income and expenditure methods) in which the flow of income can be measured. LEAKAGES AND INJECTIONS caueeee Leakages Leakages refer to withdrawal of money from the circular flow. When households and firms save a part of their incomes, it leads to a leakage from the circular flow of income. Leakage or withdrawal refers to that part of income, which does not pass through the circular flow of income. As a result, it is not available for spending on currently produced goods and services. It means, leakages reduce the flow of Income. Created with @ NotewiseExamples of Leakages in different types of economies 1. Two-sector economy _No Leakage (without Financial Market) 2. Two-sector economy _ gajings (with Financial Market) g 3. Three-sector economy - savings + Taxes 4. Four-sector economy - Savings + Taxes + Imports Injections Injection refers to the introduction of income into the circular flow. When households and firms borrow money from external sources like financial institutions, it adds to their income. Such additional income does not result in immediate expenditure. So, injections increase the flow of income. figte viseExamples of Injections in different types of Economies 1. Two-sector economy —_- No Injections (without Financial Market) 2. Two-sector economy — (with Financial Market) ~!"Jections 3. Three-sector economy - Injections + Govt. Exp. 4. Four-sector economy - Injections + Govt. Exp. + Exports lt must be noted that Equilibrium is achieved when Injections are equal to Leakages. Created with @ Notewise