What is Circular Flow of Income?

What is Circular Flow of Income?

Macroeconomics tries to study the central questions of economies. Amongst these questions, the main question is how economies create wealth. In an economy, all factors of production (FoP) undergo a production flow/cycle; in the process of which it generates wealth in the form of making payments to the factor of production, known as factor payments. Thus, the economic wealth of nations is created by generating this flow and producing commodities (goods and services), which are then consumed by consumers who spend their income on these goods and services....

Circular Flow of Income:

The circular flow of income is an economic model that reflects how money or income flows through the different sectors of the economy. A simple economy assumes that there exist only two sectors, i.e., Households and Firms. Households are consumers of goods and services and the owners of the factors of production (land labour, capital, and enterprise). However, the firm sector produces goods and services and sells them to households....

Circular Flow in a Two-sector Economy (with Financial Market)

In the circular flow of an economy in a two-sector model without the financial market, it is assumed that no savings are made in the economy. It means that the households spend their entire income on the purchase of goods and services and every firm spends all the receipts from the sale of goods and services to make factor payments....

Circular Flow in a Three-sector Economy

The government also plays a crucial role in the economic development of a country. Therefore, the circular flow of income in a three-sector economy includes households, firms, and the government sector. The government of a country acts as both a firm and a consumer. As a firm or producer, the government produces goods and services for the economy. However, as a consumer, it spends money on the consumption of goods and services produced by the firms. Besides the flows of circular income in the two-sector economy with a financial market, the additional flows due to the inclusion of the Government are:...

Circular Flow in a Four-sector Economy

Besides households, firms, and the government, the foreign sector also plays a crucial role in an economy. Therefore, the circular flow in a four-sector economy consists of households, firms, government, and the foreign sector. Money flows in each of these sectors are as follows:...