Class Notes: Circular Flow of Income

Class Notes
Class: XII Topic: CIRCULAR FLOW OF INCOME
Subject: ECONOMICS
CIRCULAR FLOW OF INCOME

The circular flow of Income refers to the flow of money, services, and goods. This
circulation happens in terms of income in the production process, distribution between the
factors of production, and at the end the circulation of the product from household to a firm in
the form of consumption expenditure on goods and services manufactured by them.
The three different phases in the circular flow of income are-

 Generation Phase- In this phase, the firm manufactures the goods and services
with the assistance of factor services.
 Distribution Phase- This phase involves the flow of factor income, which
comprises of rent, interests, wages, and profit from firm to the household.
 Disposition Phase- Here, the income collected by the factors of production, is
used on the goods and services manufactured by a firm.
Circular Income Flow in a Two Sector Economy:
Real flows of resources, goods and services have been shown in the diagram. In the
upper loop of this figure, the resources such as land, capital and entrepreneurial
ability flow from households to business firms as indicated by the arrow mark.
In opposite direction to this, money flows from business firms to the households as
factor payments such as wages, rent, interest and profits.
In the lower part of the figure, money flows from households to firms as consumption
expenditure made by the households on the goods and services produced by the firms,
while the flow of goods and services is in opposite direction from business firms to
households.
Thus we see that money flows from business firms to households as factor payments
and then it flows from households to firms. Thus there is, in fact, a circular flow of
money or income. This circular flow of money will continue indefinitely week by week
and year by year. This is how the economy functions. It may, however, be pointed out
that this flow of money income will not always remain the same in volume.
In year of depression, the circular flow of money income will contract, i.e., will
become lesser in volume, and in years of prosperity it will expand, i.e., will become
greater in volume.
become lesser in volume, and in years of prosperity it will expand, i.e., will become
greater in volume.
Types of circular flow:
 Real Flow- The term real flow means the flow of factor services from household to
firms. Similarly, the flow of goods and services from firms to household
 Money Flow- The Money flow refers to the flow of factor payments from firm to
household for factor services. Similarly, the flow of consumption expenditure from
household to firm for the purchase of goods and services manufactured by the firm.
Differences between Real Flow and Money Flow :
Basis Real flow Money Flow
Kind of It includes the exchange of goods and It only involves the

Exchange services exchange of money
Difficulty in Lots of difficulties involved in the No such difficulties in

Exchange exchange of goods and service terms of money flow
Alternative Also, know as Physical Flow Also, known as Nominal

Names Flow
Differences between Stock and Flow with examples.

Basis Stock Flow
Time There is no time dimension Time dimension exists as the

Dimension magnitude can be scaled over a
period of time
Nature of It is a static concept It is a dynamic concept

concept
Examples  Total number of  Hero Honda Car

Hero Honda bike in manufactured during
Bangalore February 2018
 National Wealth  National Income
The role of the government sector in an Economy.

Government sector performs the following activities in the economy.
 They collect taxes from households and firms
 They make transfer payments to the households and provides subsidies to the firms
 They make the payment for the purchase of goods and services from the firms
 They save and borrows money with the help of the financial market.
In a three sector economy, government plays a vital role to maintain stability in the economy.
THIS CONTENT IS DEVELOPED FROM HOME BY M.GANESH (MGN)

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Class Notes

Class: XII Topic: CIRCULAR FLOW OF INCOME

CIRCULAR FLOW OF INCOME

the form of consumption expenditure on goods and services manufactured by them.

The three different phases in the circular flow of income are-

Circular Income Flow in a Two Sector Economy:

Types of circular flow:

Basis Real flow Money Flow

Kind of It includes the exchange of goods and It only involves the

Difficulty in Lots of difficulties involved in the No such difficulties in

Alternative Also, know as Physical Flow Also, known as Nominal

Differences between Stock and Flow with examples.

Time There is no time dimension Time dimension exists as the

Nature of It is a static concept It is a dynamic concept

Examples  Total number of  Hero Honda Car

The role of the government sector in an Economy.

THIS CONTENT IS DEVELOPED FROM HOME BY M.GANESH (MGN)

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