Economics
Chapter
1
Circular Flow
of Income
By Intent Classes
Introduction
The unlimited & recurring wants of human beings have made the
production process, a continuous process.
In this Process of production, different factors of production :
(a) Land, (b) Labour, (c) Capital & (d) Enterprise
are combined together for Production of Goods & Services.
Phases of Circular Flow of Income
Production Phase
1. Generation Phase : In this process
Generation of Income
firm produces goods & services with the
help of factor of production(factor
services) supplied by Household.
Income Phase
2. Distribution Phase : Firm makes
payment to factor of production in the Distribution of Income
form of rent, wages, interest & profit
(known as factor incomes)
Expenditure Phase
3. Disposition Phase : The household
sector spends the money earned on the Disposition of Income
purchase of goods & services produced
by the Firms.(Consumption Expenditure)
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 & finally, its circulation from households to
firms in the form of consumption expenditure on goods
& services produced by them.
Stock & Flow
Stock
Stock variable refers to that variable,
which is measured at a particular
point of time.
Flow
Flow variable refers to that variable, which is
measured over a period of time.
Basis Stock Flow
Time It has a time dimension as its
Dimension It does not have a time dimension. magnitude can be measured
over a period of time.
Nature of
It is a static concept It is a dynamic concept
Concept
Examples 1. Population of India as on 1. No. of Birth during 2021
31.03.21 2. Maruti Cars manufactured
2. Total No. of Maruti Cars in Delhi during January, 2022.
3. Money Supply (money in 3. Expenditure or transactions in
circulation). money.
4. National Wealth 4. National Income
5. Quantity of Wheat stored. 5. Quantity of Wheat stored
Types of Circular Flow
Real Flow Factor Services
(Land, Labour, Capital & Enterprise)
Real Flow refers to the flow of factor
services from households to firms & Households Firms
the corresponding flow of goods &
Goods & Services
services from firms to households
Types of Circular Flow
Consumption
Money Flow Expenditure
(On Goods & Services)
Money Flow refers to the flow of factor
payments from firms to households Households Firms
for their factors services & corresponding
Factor Payments
flow of consumption expenditure from (Rent, Wages, Interest & Profit)
households to firms for purchase of goods &
services produced by the firms.
Basis Real Flow Money Flow
Meaning It is the flow of goods & services It is the flow of money between
between firms & households. firms & households.
Kind of It involves exchange of goods &
It involves exchange of money.
Exchange services.
Difficulty in There may be difficulties of barter There is no such difficulty in case
system in exchange of goods & of money flow.
exchange factor services.
Alternative
It is also known as Physical Flow. It is also known as Nominal Flow.
Name
Household Sector Producing Sector (Firms)
It includes consumers of Weaknesses
It includes all producing
goods & services & also the firms in the economy.
owner of factor of
Production.
Four Sectors of
the Economy
Government Sector
Opportunities
Foreign Sector
It acts in two capacities: It includes transaction
• As a welfare agency with rest of the world. It
involve Export & Import of
• As a producer Goods & flow of capital
between two countries
Circular Flow of Income (Two Sector Economy)
Factor Services
Consumption
Expenditure
Households Firms
Factor Payments
Goods & Services
Assumption of Circular Flow of Income
In order to make our analysis simple, we take some assumptions
1. There are only two sectors in the economy: Households & Firms. It means, there is no
government & foreign sector.
2. Household sector supplies factor services only to firms & the firms hire factor services
only from households.
3. Firm produce goods & service & sell their entire output to the households.
4. Households receive factor income for their services & spend the entire amount on
consumption of goods & services.
5. There are no savings in the economy.
Conclusions of Circular Flow of Income
In a Two-Sector Economy, the following Conclusions can be drawn:
1. Total Production of goods & services by Firms = Total Consumption of goods & services
by Households.
2. Factor Payments by Firms = Factor Incomes of Household
3. Consumption Expenditure by households = Factor Income of Households.
4. Real Flow in the form of factor services & final goods & services = Money Flow between
firms & households.
