The document summarizes the circular flow of income between key economic sectors. It describes a basic two-sector model with firms producing goods/services and households supplying labor and consuming output. Income flows from firms to households as payment for factors and back to firms as consumption spending. Savings are withdrawn from the flow. A three-sector model adds government spending and taxes. A four-sector model incorporates the external sector through imports and exports, with the goal of national income equilibrium.

1. Presented by
Aglaia
MBA IV Tri.
104 Economics for managers
Ambar Agarwal
School of Management
UNIT 4th
Circular Flow of Income
Lecture No. 7

2. Circular Flow of economic activities
• Economic interdependence of Consumers and Sellers.
• Between Consumers and Sellers the circular Flow of Goods, Services, Income and
Expenditure takes place.
• Other Entities may be Foreign Nations, Government.

3. Circular Flow of Economic Activities and Income (Two Sector economy)
The simple model of the circular flow assumes two players
Firms
• Produce and supply the goods and services.
• Require various factors of production to produce these goods and services.
Households
• Include a set of individuals living in the same house
• Take joint decision about the consumption of goods and services.
• Provide services in terms of factor inputs to the firms
• Get paid for these services by firms which households spend on consumption.
• Money flows from firms to households as factor payments and from households to
firms as expenditure on goods and services.
• It is a circular flow of money or income

4. Cont’d
• Savings are taken out of Circular flow, so these are called “Withdrawals”
• Savings deposited in Capital Markets goes to the firms as Investment Expenditure, which is
known as known as “Injections”.
• If Savings are kept with households, it is known as “Leakages”.

5. Circular Flow of Income
(Two Sector Economy)
In the equilibrium Y=C+S=C+I
(Wages, Rent, Interest and Profits)
Factor Payments
(Y)
Consumption
expenditure
(C)
Firms
Households
Goods and
Services (O)
Factor Inputs
Financial
Market Investment
(I)
Savings
(S)

6. Equilibrium
• Aggregate Income = Aggregate Expenditure
• Y = E
• Aggregate Income = C+S
• Aggregate Expenditure = C+I
• S = I
• Hence Y = E or
• Aggregate Demand = Aggregate Expenditure

7. Three Sector Model

8. Equilibrium
• Total Expenditure (E)= C+I+G
• Total Income (Y) = C+S+T
• In Equilibrium E = Y
• So C+I+G = C+S+T

9. Circular Flow of Income
(Four Sector Economy)
The third sector is Government (G)
• Government Spending
– Subsidies, defence, health care, education, infrastructure
– Provides salaries to the households
– Pays to firms for purchases of goods and services
• Government Revenue
– Households and firms pay various taxes and other payments and provide factor
inputs to the government.
– Government borrows from the financial market to fill revenue gap.
The fourth sector is the external sector
• Imports (M): Outflow of income occurs when the domestic firms buy goods and services
from foreign ones.
• Exports (X): Inflow of income takes place when foreign firms buy goods and services from
domestic ones

10. Circular Flow of Income
(Four Sector Economy)
Government
(G)
Remittances
for purchases
Foreign Nations
(X-M)
Salaries
Taxes
Taxes
Consumption
Expenditure
Financial Market
Investment
(I)
Savings
(S) Firms
Households
Factor Inputs
Goods
(O)
Factor
Payments
Imports
(M)
Imports
(M)
Exports
(X)
Exports
(X)
National Income=C+I+G+(X-M)