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It is a model showing flow of goods, services and money from Firm to Household and Households to Firms

As per this Model

Firm Sells all their goods and Services to households

Households sell all their Factor Services (land, Labour etc) to Firms

Firms Pay Factor Payments to Household for use of Factor Service

Households pay Consumption expenditure for use of goods and services

Assumptions

  1. There are only 2 sectors in Economy - Firms and Households
    (There is no Government or External Sector)
  2. There is no Savings
    Firms spend all their profits on factor services.
    Households spend all their expedite on Factor Payments
  3. It is closed economy (no dealing with outside country)

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Note

Circular flow denotes both Real Flow and Money Flow

 

Outer loop denotes Real flow - Exchange of goods and services between firms and Households

Inner loop denotes Money flow - Exchange of money between firms and households

 

In the Circular Flow of Income

Production activities generate Factor Income (Factor Payments made to households by firm).

This Factor Income is then converted into Expenditure (Consumption Expenditure paid to firms by households).

This flow of income continues as Production is a continuos activity due to never-ending human wants.

It makes the flow of income circular.

 

Phases of Circular flow of Income

There are three phases in Circular flow of Income:

  1. Generation Phase - In this phase, firms produce goods and services with the help of factor services.
  2. Distribution Phase - This phase involves the flow of factor income (in the form of rent, wages, interest and profit) from firms to households.
  3. Disposition Phase - In this phase, the income received by factors of production is spent on the goods and services produced by firms.

 

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NCERT Questions

Question 2

Why should the aggregate final expenditure of an economy be equal to the aggregate factor payments?

Explain.

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Other Books

Question 1

In a two-sector economy, there is no _____ and _____ sector.

View Answer

Question 2

In the ___ phase, income received by factors of production, is spent on goods and services produced by _____.

View Answer

Question 3

What is the function of households in the circular flow (two-sector model)?

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Transcript

It is a model showing flow of goods, services and money from Firm to Household and Households to Firms As per this Model Firm Sells all their goods and Services to households Households sell all their Factor Services (land, Labour etc) to Firms Firms Pay Factor Payments to Household for use of Factor Service Households pay Consumption expenditure for use of goods and services Assumptions 1 There are only 2 sectors in Economy - Firms and Households (There is no Government or External Sector) 2 There is no Savings Firms spend all their profits on factor services. Households spend all their expedite on Factor Payments 3 It is closed economy (no dealing with outside country) What is Circular Flow of Income It is a model showing flow of goods,services and money from Firm to Household and Households to Firms It Assumes Only 2 Sectors in Econpmy Firm Household (No Governemnt or External Sector) Diagram of Circular Flow of Income FIRMS Sell goods and Services Factor Service (Land labour) Factor Payments Consumption Expendute HOUSEHOLDS Firm Sells all their goods and Services to households Households sell all their Factor Services (land,Labour etc) to Firms Firms Pay Factor Payments to Household for use of Factor Service Households pay Consumption expenditure for use of goods and services Note Circular flow denotes both Real Flow and Money Flow Outer loop denotes Real flow - Exchange of goods and services between firms and Households Inner loop denotes Money flow - Exchange of money between firms and households In the Circular Flow of Income Production activities generate Factor Income (Factor Payments made to households by firm). This Factor Income is then converted into Expenditure (Consumption Expenditure paid to firms by households). This flow of income continues as Production is a continuos activity due to never-ending human wants. It makes the flow of income circular. Phases of Circular flow of Income There are three phases in Circular flow of Income: 1 Generation Phase - 2 Distribution Phase - 3 Disposition Phase - Circular flow denotes both Real Flow and Miney Flow FIRMS Sell goods and Services Factor Service (Land labour) Factor Payments Consumption Expendute HOUSEHOLDS This is Real flow Exchnge of goods and services between Firms and Households This is Rmoney flow Exchange of money between Firms and Households In the Circular Flow of Income Production activities generate Factor Income (Factor Payments made to households by firm). This Factor Income is then converted into Expenditure (Consumption Expenditure paid to firms by households). This flow of income continues as Production is a continuos activity due to never-ending human wants. It makes the flow of income circular. In the Circular Flow of Income Production activities generate Factor Income (Factor Payments made to households by firm). This Factor Income is then converted into Expenditure (Consumption Expenditure paid to firms by households). This flow of income continues as Production is a continuos activity due to never-ending human wants. It makes the flow of income circular. Phases of Circular flow of Income There are three phases in Circular flow of Income: 1 Generation Phase - In this phase, firms produce goods and services with the help of factor services. 2 Distribution Phase - This phase involves the flow of factor income (in the form of rent, wages, interest and profit) from firms to households. 3 Disposition Phase - In this phase, the income received by factors of production is spent on the goods and services produced by firms.

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Davneet Singh is a graduate from Indian Institute of Technology, Kanpur. He has been teaching from the past 12 years. He provides courses for Maths and Science at Teachoo.