CIRCULAR FLOW OF NATIONAL

INCOME

by Bishan Sanyal
Associate professor in Economics of Nabagram Hiralal Paul
college, Konnagar, Hooghly
Affiliated to Calcutta University
TWO ASSUMPTIONS
 IN ANY EXCHANGE PROCESS, THE SELLER OR,
PRODUCER RECEIVES THE SAME AMOUNT
WHAT BUYER OR CONSUMER SPENDS.
 GOODS AND SERVICES FLOW IN THE SAME

DIRECTION.
In a modern two sector economy, money
acts as medium of exchange.
 Money flow of income refers to a monetary payment
from households to firms in against of purchasing
goods and services produced by firms. This is flow of
product approach and sums up the total expenditure
of the economy.
 Household sector gets monetary reward in the form

of rent, wages, interest and profit in against of their

services offered such as land, labour, capital and
organisation as means of production. This is income
approach and sums up total income of the economy.
Three Sector Model
 Household Sector : People belonging to this sector, supplies
factors of production and demands goods and services.
 Business Sector : People belonging to this sector, demands

factors of production and supplies goods and services.

 Government Sector: When market fails to organise

economic activity, people belonging to this sector collects

tax direct from household sector income and indirect tax
from business sector and spends to build infrastructure
going to business sector as well as giving subsidies to
household sector.
The Simple Circular Flow (cont'd)

 Product Markets Flow of Product Approach Two

Sector
◦ Transactions in which households buy goods

8-5
Income Approach

 Two Sector
Circular Flow

Factor
Business Payments-Rent,
Sector Wage, Interest
rate & Profit

Factors of production-
Household
Land, Labour, capital
& organisation Sector
Circular Flow with two sector
 The Circular Flow
Wages, rents, interest,
profits

Factor services

Goods
Firms (production)
Household
rnm ent
Taxes Government Gove nding
Spe
Savin
gs es t ment
Financial markets Inv
Imp Personal consumption
orts
rts
Expo
Other countries

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

 Governme
nt

Financial
Household
s Institutio Firms
ns

Rest of the
world
Various Transactions between four sectors and Financial
Sector