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CircularFlow

The circular flow of income shows the continuous flow of money between households and firms. Households provide factor services like labor, capital, land and entrepreneurship to firms and receive factor incomes. Firms use these factor services to produce goods and services and sell them to households. Households use their incomes to purchase goods and services from firms. This continuous flow creates the circular flow of income in a closed economy. In an open economy, the circular flow is affected by international trade through exports, imports and international factor movements.

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Johar Menezes
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223 views4 pages

CircularFlow

The circular flow of income shows the continuous flow of money between households and firms. Households provide factor services like labor, capital, land and entrepreneurship to firms and receive factor incomes. Firms use these factor services to produce goods and services and sell them to households. Households use their incomes to purchase goods and services from firms. This continuous flow creates the circular flow of income in a closed economy. In an open economy, the circular flow is affected by international trade through exports, imports and international factor movements.

Uploaded by

Johar Menezes
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

Circular Flow of Income

1
Process of Income Generation and Circular Flow of
Income
Factor Incomes = Wages + Interest + Rent+ Profits = Factor Prices

FOP: Labour, Capital, Land, Organization

Household:
Firms:
Factor Owners and
Factor Users and
Customers
Producers
Goods and Services

Payments for Goods and Services = Value of Output

2
Circular Flow of Income in an Open Economy

11 Personal Savings
Financial Institutions
Deposits 1

13
Government Savings 5 Repayments
(+ve or –ve)
Corporate Tax
4 14
Investments
NDI + TP 8 Government Indirect Tax 2
Personal Tax 3 Subsidy
HDT
12
7 9 Govt. Exp.
6 [Rents+Wages+Interest+Profit]
Households Firms

FOP 10 Private Consumption GNP


15
Footnotes: Receipts for
1. FOP : Factors of Production
exports (X)
2. GNP: Gross National Product 16
3. NDI : National Debt Interest of domestic debt Rest of the World Payments for imports (M)
4. TP : Transfer Payments 3
5. HDT: Household Direct Tax
Notes to Circular Flow of Income
A. Assumptions Underlying the Circular Flow of Income
i. All production takes place at firms
ii. All investments are made by firms
iii. All savings go to financial institutions

B. Circular flow of income shows following leakages (withdrawals) from


the national income, which do not form a part of expenditure on
national product:
Savings (S), Taxes (T) and Imports (M)

C. Also it indicates following injections (additions) into expenditure on


national product, which do not come from national income:
Investments (I), Government Expenditure (G) and Exports (X)

D. In equilibrium total planned leakages must equal total planned


injections; i.e.,
S+T+M=I+G+X

E. In an open economy there can be 3 gaps i.e.,


S ≠ I (Saving – investment gap) ; T ≠ G (fiscal deficit/surplus) and M ≠ X
deficit/surplus on current account of BOP) 4
but the sum of the three gaps must equal zero

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