2. Household Sector Business Firms/Producer
Sector
Land , Labour, Capital, Entrepreneurship
Good and Services
Real Flow
3. HS BF
FM
S I
Land , Labour, Capital, Entrepreneurship
Good and Services
Expenditure on Goods and Services
Rent , Wages/Salary, Interest, Profit
G
T T
F
6. Circular Flow of Income and Expenditure
• Two Sector Economy
• Three Sector Economy
• Four Sector Economy
7. Household Sector
Business Firm/Producer
Sector
Land, Labour, Capital, Entrepreneurship
Goods and Services
Factors of Production
Rent, Wages,Interest, Profit
Payment of Factors of Production
Expenditure on Good and Services
Real Flow
onetary
ow
8.
9.
10.
11. Assumptions
a) The economy consists of two sectors (i) Households and (ii) Firms.
b) Production takes place only in firms
c) Household spend than entering income received in the form of wages, interest, rent, on goods services i.e.
no savings.
d) Firm supply goods and services as per the demand,
e) There are no government operations,, i.e. no government expenditure and taxes in the economy.
f ) There are no international economic relations. There is no outflow and inflow of goods and services in a
closed economy.
14. A foreign remittance is a transfer of money from a
foreign worker to their families or other individuals in their
home countries.
15. The circular flow of income and expenditure refers to the
process whereby the national income and expenditure of an
economy flow in a circular manner continuously through time.
16. We begin with a simple hypothetical economy where there
are only two sectors, the household and business. The
household sector owns all the factors of production, that
is, land, labour and capital. This sector receives income by
selling the services of these factors to the business sector
17. The business sector consists of producers who produce
products and sell them to the household sector or
consumers. Thus the household sector buys the output of
products of the business sector. The circular flow of
income and expenditure in such an economy is shown in
Figure 1 where the product market is shown in the upper
portion and the factor market in the lower portion.
In the product market, the household sector purchases
goods and services from the business sector while in the
factor market the household sector receives income from
the former for providing services. Thus the household
sector purchases all goods and services provided by the
business sector and makes payments to the latter in lieu of
these.
18. The business sector, in turn, makes payments to the
households for the services rendered by the latter to the
business-wage payments for labour services, profit for
capital supplied, etc. Thus payments go around in a
circular manner from the business sector to the household
sector and from the household sector to the business
sector, as shown by arrows in the output portion of the
figure.
19. There are also flows of goods and services in the opposite
direction to the money payments flows. Goods flow from
the business sector to the household sector in the product
market, and services flow from the household sector to the
business sector in the factor market, as shown in the inner
portion of the figure. These two flows give GNP=GNI.
20. Adding these, we have:
Y = C + I
Where, Y denotes national incomes, C private
consumption spending and I private investment spending.
21. Expenditure has now two alternative paths from household and product
markets:
(i) Directly via consumption expenditure, and
(ii) indirectly via investment expenditure.
In Figure 2 there is a capital or credit market in between saving and investment flows from
households to business firms. The capital market refers to a number of financial
institutions such as commercial banks, savings banks, loan institutions, the stock and bond
markets, etc. The capital market coordinates the saving and investment activities of the
households and the business firms. The households supply saving to the capital market and
the firms, in turn, obtain investment funds from the capital market.
22. This sector adds three key elements to the circular flow model,
i.e., taxes, government purchases and government borrowing.
The government levies taxes on the households and the firms
and it also gives subsidies to the firms and transfer payments to
the household sector.
Thus, there is income flow from the household and firms to the
government via taxes in one direction and there is income
outflow from the government to the household and firms in the
other direction.
If the government revenue falls short of its expenditure, go to
borrowing through financial markets.
Three sector model
23. Y = C + I + G Where,
Y = Income;
C = Consumption;
I = Investment and
G = Government Expenditure
24. IMPACT OF COVID 19 ON CIRCULAR FLOW OF THE ECONOMY
• In a pandemic uncertain situation like covid-19 and lock down -people are
insecure of their jobs and earnings, try to save their money instead of spending
for the future.
• Business firms also face low demand for goods and services, see decline in their
profit. Banks are shy of giving credits to entrepreneurs.
• As a result investment plummeted in a short time. Government collects low taxes
from firms and families, get low revenue but its expenditure will be abnormally
increased on economic rehabilitation packages so its debt would be raised.
• There would-be low imports and at the same time low exports due to lockdown
worldwide which impact worst on global GDP growth in the coming days.
• Finally, all injections are failed in this period, leakages are increased which leads
to low or negative national income growth in many countries including India in
2020-21.
25. Household Sector
Receipts
The household sector receives factor income in the form of rent, wages,
interest, and profit from the business sector. It also receives transfer payments
from the government sector.
Payments
The income of the household sector flows into the business sector,
government sector and capital markets in the form of consumption
expenditure, taxes and savings respectively
26. Business Sector
Receipts
The principle receipts of the business sector constitute of income from the sale of
goods and services, income from exports, subsidies from the government sector, and
borrowings from the capital market.
Payments
Factor payments, import payments, and savings constitute the principal payments from
the business sector to the household sector, government sector, foreign sector and the
capital market.
27. Government Sector
Receipts
The major source of income for the government sector include the taxes paid
by household and business sector. Besides this, it also receives interests and
dividends for the investments made.
Payments
The government sectors make payments to different sectors in the form of
transfer payments, subsidies, grants, etc. It pays to the business sector in
return for the goods purchased, makes transfer payments like pension funds,
scholarships, etc. to the household sector.
If the government receipts are greater than the expenses, the surplus goes to
capital market. In case of cash deficit, the government borrows from the
capital market to maintain a balance in the economy.
28. Foreign Sector
Receipts
The foreign sector receives income from the business sector in return for the
goods and services imported by the latter.
Payments
Foreign sectors need to make payment to the business sector from where imports
have been made.
If exports exceed imports, the economy has a surplus balance of payment. In case
exports exceed imports, the economy faces a deficit balance of payment.
Depending on the trade policies, the economy tries to maintain a balance between
imports and exports.
29. Capital Market
Household, business, and government sectors deposit their excess of income to the capital
markets as savings. These savings are borrowed by the business sector or government
sector for making investments in different projects.
