ECONOMICS
C H 1 – C I RCULAR F L O W O F I N COME
Revision…
FACTORS OF PRODUCTION FACTOR PAYMENTS
❑Land ❑Rent
❑Labour ❑Wages
❑Capital ❑Interest
❑Entrepreneur ❑Profits
PHASES OF CIRCULAR FLOW OF INCOME
Production
Phase
Generation of Income
Expenditure Income
Phase Phase
Disposition of Income Distribution of Income
Circular Flow of Income
Circular Flow of Income refers to a cycle of
generation of income in the production process,
its distribution among factors of production in the second phase
and finally its circulation from households to firms in the form
of consumption expenditure on goods and services provided by
them.
Sectors of the Economy
➢Households
➢Firms
➢Government
➢Foreign Sector
Stock and Flow
Basis Stock Flow
Stock variable refers to that Flow variable refers to that
Meaning variable, which is measured at a variable, which is measured over a
particular point of time. period of time.
Time It has time dimension as it can be
It does not have time dimension.
Dimension measured over a period of time.
Nature of
It is a static (stationary) concept. It is a dynamic concept.
Concept
Bank balance, money supply,
Profit, Loss, savings, production,
Examples national wealth, quantity of goods
population growth during 2018.
stored, etc.
Flow are of two types:-
• Real Flow
• Money Flow
Real Flow and Money Flow
Basis Real Flow Money Flow
It refers to a situation in which
It refers to a situation where firms provide factor payments to
households provide factor services the households corresponding to
Meaning to the firm corresponding to which which, the households make
the firms provide goods and payment to the firms for goods
services to the households. and services produced by the
firms.
Transaction
Goods and Services Money
mode
It is less difficult to make
Difficulty in It is more difficult to make
exchange due to involvement of
exchange exchange due to barter system.
money.
Other name Physical Flow Nominal Flow
Diagram
Circular Flow of Income
(TWO SECTOR MODEL)
In order to understand the circular flow of income under a simple economy
of two sectors, there are certain assumptions:
→ There are only two sectors in the economy i.e. households and firms.
→ There are no savings in the economy.
- Households are the owner of the factors of production and consumers of
goods and services.
- Firms are those units that undertake production and sell them to the
households.
Payment for Goods and Services
Factors of Production
Land, labour, capital, entrepreneur
Households Firms
Goods and Services
Rent, Wages, Interest, Profits
Factor Payments
- In the initial phase, households provide factor services to the firms for
doing production, in return of which the firms provide factor payments
to them in the form of rent, wages, and interests and profits.
- With the help of the factors of production, the firms produces goods
and services and sell them to households and the households uses the
factor income to buy goods and services from the firms in the form of
consumption expenditure.
- Hence, the income flows first from the firms to the households in the
form of factor payments and then, from households to firms in form of
consumption expenditure. Hence, this completes the circular flow of
income in case of two -sector model.
STOCK OR FLOW
• Amount of Bank Deposits as on 31/03/20
• Profits
• Population of India as on 1/4/20
• National Income
• Capital
• Production
• Wealth
• National Wealth
• Depreciation
• Expenditure
• Imports
• Stock kept in Warehouse
• Savings
