The document discusses circular flow models which show the linkages between different sectors of the economy and how money flows between them. It describes the two sector model consisting of households and industry, the three sector model which adds government, and the four sector model that also includes financial and foreign sectors. The circular flow models illustrate how households supply factors of production like labor to businesses in exchange for factor incomes, and how businesses provide goods and services to households in exchange for spending. They can be used to understand national income calculation, trade policies, and monetary policy.

1. THE CIRCULAR FLOW OF
INCOME
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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.
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3. Types of circular flow models
• Two sector model
• Three sector model
• Four sector model
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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.
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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.
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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.
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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.
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