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THE CIRCULAR FLOW OF
INCOME
1
What is a circular flow of income?
• The circular flow of income shows the
connection or linkages between different
sectors of the economy.
• It can be explained with the help of economic
models.
• The circular flow model
is a picture of market economy in
action. It tells how the money
flows in the economy.
2
Types of circular flow models
• Two sector model
• Three sector model
• Four sector model
3
Two sector model
• It consists of household sector and the
industrial sector.
• Household sector demand goods and services
and they provide labour resources to the
business sector.
• Industrial sector produce and supply goods and
services to the household sector
Businesses demand resources for production: land,
labour, capital, and entrepreneurs.
4
5
Household sector
Firms/ industrial sector
Factor Services
Factor Incomes
Factor Services
Factor Incomes
Wages/Salaries
Interest
Profit
Rent
Labour
Capital
Entrepreneur
Land
Spending
Products
Three sector model
It is called the closed economy model.
It includes the
household sector
industrial sector
government sector – the government
collects taxes to provide resources and
services to the people.
6
Product
Markets
Factor
Markets
goods & services… ….goods & services
….consumption spending….
….salaries, wages, rent, dividends…..
land, labor, capital…… …entrepreneurial ability
Government sector
Household sector
industrial sector
Product
Markets
Factor
Markets
goods & services… ….goods & services
….consumption spending….
….salaries, wages, rent, dividends…..
land, labor, capital…… …entrepreneurial ability
Household sector
industrial sector
Product
Markets
Factor
Markets
goods & services… ….goods & services
….consumption spending….
….salaries, wages, rent, dividends…..
land, labor, capital…… …entrepreneurial ability
Personal Income Taxes
Corporate Income Taxes
Household sector
industrial sector
Product
Markets
Factor
Markets
goods & services… ….goods & services
….consumption spending….
….salaries, wages, rent, dividends…..
land, labor, capital…… …entrepreneurial ability
Personal Income Taxes
Corporate Income Taxes
transfer payments subsidies
Household sector
industrial sector
Four sector model
• The is called the open economy model.
• It consists of
household sector
industrial sector
government sector
financial sector and the
foreign sector.
11
12
13
Uses of circular flow models
• It gives the clear picture of the market
economy.
• It helps in the calculation of national income.
• Formulation of trade policies which promotes
the exports and reduces the imports.
• It explains the importance of monetary policy
by establishing equilibrium between savings
and investment.
14
15

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Circular flow of income.ppt

  • 1. THE CIRCULAR FLOW OF INCOME 1
  • 2. What is a circular flow of income? • The circular flow of income shows the connection or linkages between different sectors of the economy. • It can be explained with the help of economic models. • The circular flow model is a picture of market economy in action. It tells how the money flows in the economy. 2
  • 3. Types of circular flow models • Two sector model • Three sector model • Four sector model 3
  • 4. Two sector model • It consists of household sector and the industrial sector. • Household sector demand goods and services and they provide labour resources to the business sector. • Industrial sector produce and supply goods and services to the household sector Businesses demand resources for production: land, labour, capital, and entrepreneurs. 4
  • 5. 5 Household sector Firms/ industrial sector Factor Services Factor Incomes Factor Services Factor Incomes Wages/Salaries Interest Profit Rent Labour Capital Entrepreneur Land Spending Products
  • 6. Three sector model It is called the closed economy model. It includes the household sector industrial sector government sector – the government collects taxes to provide resources and services to the people. 6
  • 7. Product Markets Factor Markets goods & services… ….goods & services ….consumption spending…. ….salaries, wages, rent, dividends….. land, labor, capital…… …entrepreneurial ability Government sector Household sector industrial sector
  • 8. Product Markets Factor Markets goods & services… ….goods & services ….consumption spending…. ….salaries, wages, rent, dividends….. land, labor, capital…… …entrepreneurial ability Household sector industrial sector
  • 9. Product Markets Factor Markets goods & services… ….goods & services ….consumption spending…. ….salaries, wages, rent, dividends….. land, labor, capital…… …entrepreneurial ability Personal Income Taxes Corporate Income Taxes Household sector industrial sector
  • 10. Product Markets Factor Markets goods & services… ….goods & services ….consumption spending…. ….salaries, wages, rent, dividends….. land, labor, capital…… …entrepreneurial ability Personal Income Taxes Corporate Income Taxes transfer payments subsidies Household sector industrial sector
  • 11. Four sector model • The is called the open economy model. • It consists of household sector industrial sector government sector financial sector and the foreign sector. 11
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  • 14. Uses of circular flow models • It gives the clear picture of the market economy. • It helps in the calculation of national income. • Formulation of trade policies which promotes the exports and reduces the imports. • It explains the importance of monetary policy by establishing equilibrium between savings and investment. 14
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