Circular Flow of Income

 

Circular Flow of Income

Definition: Circular flow of Income refers to the movement of money and goods, in the economy, across the various sectors, i.e. household, firm, government and foreign sector, in a circular flow.

An economy can be defined as a unified arrangement of production, distribution, exchange, consumption and investment.

These processes play a crucial role in the survival and growth of the economy. Consumers buy the goods and services produced by the producers for money, which generates income. And so, the income generated in the process moves in a circular motion. This is called the circular flow of income. Further, it is an ongoing process, as there is no end to the flow.

Economic Sectors

An economy is classified into four broad sectors, these are:

1.   Household Sector: This sector covers consumer of goods and services, who buys them for their personal consumption. The household sector owns the inputs, i.e. factors of production and renders factor services to the producer sector.

2.   Producer Sector: All the producer firms and establishments fall under this category. Firm employ factors of production, i.e. land, labour, capital and entrepreneur, so as to produce goods and services. As the inputs are owned by the households, factors payments are made to them in the form of rent, salary and wages, interest and profit.

3.   Government Sector: It is the third sector of the economy which earns revenue in the firms, households and foreign sectors, in the form of taxes, fees, duties, and proceeds from the sale of goods and services. Also, the government makes factor payments to the households and provides public utility services to the general public.

4.   External Sector: It is the foreign sector which receives money for the export of goods and services to the firms, household and government. Also makes payment to the other sectors for the import of goods and services.

Types of Circular Flow of Income

There are two types of circular flow, explained hereunder:

·       Real Flow: Otherwise called as Product Flow or Output Flow, it implies the movement of factor services and, goods and services among different sectors of the economy. Thus, it comprises of:

Ø  Factor Flow

Ø  Product Flow

·       Money Flow: Money Flow or Nominal flow involves the exchange of goods and services for money. Households provide factor services to the firm, in the form of land labour, capital and entrepreneur and get factor payments for the same, in terms of money. Now the money received is spent on buying goods and services produced by the firm.

Phases of Circular Flow of Income

In general, circular flow is bifurcated into three major phases which are:

 ·    Production Phase: In this phase, goods and services are manufactured by the firms, by making use of inputs, for the purpose of production of goods and services. As it leads to the generation of income, it is called a generation phase.

·       Distribution Phase: In this part, the firm makes factor payments to the households, in the form of rent, wages, interest and profit, for the factor services provided by them. Hence, there is a distribution of income.

·       Disposition Phase: Finally, the factor incomes received is invested in the purchase of goods and services for the purpose of consumption. Hence, there is the disposition of income in this phase.

K.Aswin (21UCM054)

M.D.R.Hariharan (21UCM065)

II B.Com ‘B’