Circular Flow of Income


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

The circular flow of income is explained with a simplest model consisting business (firms or producers) and public (households or consumers). The public own the productive resources (i.e. factors of production namely land, labour and capital). Business
sector or producers employ the factors of production to produce the goods and services. Such goods and services are bought by the public.
 
Thus public own the factors of production and provide them to producers. The producers employ the factor inputs to produce output of goods and services, which is bought by the consumers (public). For the employment of factor services, the public receive the factor income namely
rent (for land), wages (for labour) and interest (for capital). This income flows back from the public to the business sector as consumption expenditure to buy the goods and services.
 
Thus, the flow chart consist two segments – real flow and money flow. As the outer flow in Figure 4.1 shows the flow of input (factors viz. land, labour, capital and organisation) and output (goods and services), they represent the real economy (or real flow). The inner flow shows the
money received as factor income (rent, wage, interest, and profit) and it goes to the producer as consumption expenditure (commodity price) to buy the goods and services. As this flow chart involves only income received and expenditure made in terms of money, it represents the money economy (or money flow).
 
The most important point to be noted for the computation of national income is that income (Y) received is equal to the consumption expenditure (C) made by the consumers, i.e. Y=C.
 
 
This simple circular flow model is explained without the other components of national income namely savings or investment (I), public expenditure by government (G) and expenditure on net exports (X-M). If we include all the above components of national income Y= C will become
 
Y = C + I + G + (X-M)
 
Thus national income is the aggregate summation of income or expenditure made through these four components, consumers (C ), investors (I), government (G) and foreign trade (Exports [X] – Imports [M] )


Friday, 18th Mar 2016, 05:38:13 AM

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