Circular Flow of Income, Methods, Types
The constant flow of commodities and services, income, and spending in an economy is the circular flow of income. Continue Reading to learn more!
Izhar Ahmad28 Nov, 2023
Share
The idea of the circular flow of income is associated with money movement within an economy. It involves two main participants in this economic cycle: businesses and households. Businesses play a key role by making goods and services, hiring workers, paying them wages, and gaining income by selling their products. On the other hand, households buy goods and services, hire people, give them salaries from their earnings, and deal with their remaining funds after meeting their necessary costs.
What is the Circular Flow of Income Model?
The circular flow of income model simply shows the constant flow of money between households and businesses within an economy. It shows the ongoing exchange where households provide work and resources to businesses, getting income in return. This gained income is then spent on goods and services created by businesses, completing the economic circle.Phases in Circular Flow of Income
Usually, a simple or closed economy undergoes three distinct phases in the circular flow of income: Production Phase: This stage is primarily focused on generating income. Income Phase: It involves the transfer of factor income, such as rent, wages, interest, and profits, from production firms to households. Expenditure Phase: In this phase, the income generated through factors of production is predominantly expended on goods and services produced by firms.5 Assumptions of Circular Flow of Income in Two Sector Economy
The five assumptions directing the circular flow of income in a basic, two-sector economy are as follows:- The economy comprises only two sectors—Households and Businesses—and works as a closed system without participation from the government or foreign sectors.
- Households exclusively provide factor services to businesses, and businesses solely receive factor services from households.
- Businesses make things and services entirely for households, selling their entire output to them.
- Households receive factor income in return for the services provided to businesses and utilize the entire income for the consumption of goods and services.
- Savings are nonexistent in this economy, suggesting that neither businesses save profits nor individuals save factor income.
Types of Flow in the Circular Flow of Income
The circular flow includes two core aspects: real flow and money flow. Both ideas show the exchange of money for things and services. Real Flow: The real flow includes two important streams: the transfer of factors of production, such as land and labor, from people to businesses, and the transferring of goods and services from businesses to individuals. This layer shows how the economy produces and uses goods and services. Money Flow: The money flow includes the transfer of money and different kinds of loans within the business. It happens when businesses repay workers for their labor and when people use their earnings to pay for goods and services. Within the money flow, income changes into savings and investments before coming back into the economic cycle.Looking for the Best Commerce Coaching?
Enroll Now in PW Commerce Batches!
What is National Income?
National income represents the overall value of goods and services generated within an economy over a fiscal year. Simply put, it is the total income or monetary value acquired by a country from diverse economic activities throughout a financial year. National income serves as a comprehensive gauge of an economy's performance and can be computed through three distinct approaches: the Value-added or Product Method, Income Method, and Expenditure Method.Methods to Calculate National Income
National income (NY) may be calculated using any of the three methods listed below:- Value added method or Product method
- Income method
- Expenditure method
Value Added Method
The Value Added method serves as a means to assess the National Income of an economy across various production stages within the circular flow. In the production of goods or services, different units contribute to the process, and the Value Added method elucidates the specific value or contribution of these units. In the creation of a final product, each industry or enterprise adds value, acquiring intermediate goods from other firms for production. To determine the National Income, the Value Added by individual firms in this process is aggregated. This method is also known by other names such as the Product Method, Inventory Method, Commodity Service Method, Industrial Origin Method, and Net Output Method.Income method
The Income Method determines the National Income of an economy by considering that the earnings of a firm for its goods and services are utilized for factor payments. Simply put, to compute the national income through the Income Method, the incomes received by a country's residents for their productive services over a year are aggregated. These incomes, pertaining to factors of production, come in the form of profits, wages, interest, rent, etc. Other terms for the Income Method include the Distributive Share Method and Factor Payment Method.Expenditure Method
The Expenditure Method for computing National Income focuses on the ultimate spending within an economy. It accounts for the factor income earned by various factors of production, which is subsequently used by different sectors of the economy for expenditures on goods and services produced by firms. In this approach, the total final expenditures made by the government, households, foreigners, and business firms on the acquisition of goods and services are combined. An alternative term for the Expenditure Method is the Income Disposable Method.Circular Flow of Income FAQs
Who was the first Indian to calculate national income?
Dadabhai Naoroji was the first Indian to calculate national income.
What is GDP and GNP?
GDP measures the value of goods and services produced within a country, while GNP includes income earned by a country's residents at home and abroad.
Who announces GDP in India?
The National Statistical Office (NSO) in India announces the GDP figures.
Who was the first chairman of the National Income Committee?
Prof. P.C. Mahalanobis was the first chairman of the National Income Committee.
Why is India called a mixed economy?
India is termed a mixed economy because it incorporates elements of both socialism and capitalism in its economic structure.
Talk to a counsellorHave doubts? Our support team will be happy to assist you!
Check out these Related Articles
Join 15 Million students on the app today!
Live & recorded classes available at easeDashboard for progress trackingMillions of practice questions at your fingertips
Free Learning Resources
PW Books
Notes (Class 10-12)
PW Study Materials
Notes (Class 6-9)
Ncert Solutions
Govt Exams
Class 6th to 12th Online Courses
Govt Job Exams Courses
UPSC Coaching
Defence Exam Coaching
Gate Exam Coaching
Other Exams
Know about Physics Wallah
Physics Wallah is an Indian edtech platform that provides accessible & comprehensive learning experiences to students from Class 6th to postgraduate level. We also provide extensive NCERT solutions, sample paper, NEET, JEE Mains, BITSAT previous year papers & more such resources to students. Physics Wallah also caters to over 3.5 million registered students and over 78 lakh+ Youtube subscribers with 4.8 rating on its app.
We Stand Out because
We provide students with intensive courses with India’s qualified & experienced faculties & mentors. PW strives to make the learning experience comprehensive and accessible for students of all sections of society. We believe in empowering every single student who couldn't dream of a good career in engineering and medical field earlier.
Our Key Focus Areas
Physics Wallah's main focus is to make the learning experience as economical as possible for all students. With our affordable courses like Lakshya, Udaan and Arjuna and many others, we have been able to provide a platform for lakhs of aspirants. From providing Chemistry, Maths, Physics formula to giving e-books of eminent authors like RD Sharma, RS Aggarwal and Lakhmir Singh, PW focuses on every single student's need for preparation.
What Makes Us Different
Physics Wallah strives to develop a comprehensive pedagogical structure for students, where they get a state-of-the-art learning experience with study material and resources. Apart from catering students preparing for JEE Mains and NEET, PW also provides study material for each state board like Uttar Pradesh, Bihar, and others
Copyright © 2025 Physicswallah Limited All rights reserved.