National income part 2
Circle Flow of Income
1. In every economy three activities never stop: (1) Production of goods and services, (2)
generation of income in the term of rent, wage, profit, interest, (3) expenditure in term of
consumption expenditure and investment expenditure.
2. In fact, these activities are the lifeline of an economy.
3. The concept of economy does not exist without these activities.
4. It is difficult to trace the beginning and end of these activities.
5. Production, income and expenditure are flow variable.
Circle flow means:
A) It refers to the unending flow of activities of production, income and expenditure
involving different sectors of the economy. In fact production, income and expenditure
are the three phases of a circular flow in the economy.
B) Each activity is cause and consequence of the other activity for example production of
the producing sector generates income of household sector. Similarly, expenditure by
the households generates demand for further production.
C) Accordingly, production, income generation and expenditure keep chasing each other
like three dots continuously moving in a circle.
The Curve shows:
1) Production of goods and services cause generation of income
National income part 2
2) And generation income cause expenditure in the economy
3) Expenditure cause more demand in the economy which leads more production once
again.
4) Consequently, again there is generation of income and generation of expenditure.
5) The flow of production, income and expenditure form acircularity with no beginning or
an end.
6) That is the reason, it is called circle flow.
Sectors of an economy
1)
2)
3)
4)
Household sector
Producer sector
Government sector’
Rest of the world sector.
2 sector economy
In 2 sector economy, there are only 2 sectors exist which perform economic activities namely
household and producer sector. Household supply factor services to producer sector and household
spend their entire income on consumption. Producer sells what is produced to households.
Household sector:
Receipt of household:
1. Factor payments from the producer sector such as rent for land, wages for
labour, interest for capital and profit for entrepreneurship.
2. Goods and services from the producer sector.
Payment of the household:
1. Household provides factor services such as land, labour, capital and
entrepreneurship to producer sector.
2. Consumption expenditure on the purchase of goods and services.
Produces sector:
Receipt of producer:
1. Producer received factor services such as land, labour, capital and
entrepreneurship from household services.
2. Consumption expenditure of the household becomes income of the producer
sector.
Payment of the producer:
National income part 2
1. Producer sector gives factor payment to the household such as rent for land,
wages for labour, interest for capital and profit for entrepreneurship.
2. Producer sector provides goods and services to household sector.
Assumptions of 2 sector economy:
1.
2.
3.
4.
5.
There are only sector working in the economy.
There is no saving by the household
There is no Investment
There is no government control.
There is close economy mean; there is no export and import.
Diagram:
2 sector with finance sector......
In a 2 sector economy, there are 2 sectors namely, household, producer.
Assumption of 2 sectors with finance modal:




There are 2 sectors working in an economy.
Household does not spend their entire income on the purchase of goods and services.
There is no government control.
There is close economy means there is no export and import in the economy.
Explanations:
Household sector:
Receipts of the household:

Factor income from the producer sector
National income part 2

Borrows from financial sector.
Payments:


Household sector makes payment to the producing sector as consumption
expenditure.
Household deposit their saving with financial sector.
Producer sector:
Receipts of the producer sector:


Producer sector receives income from household sector on account of its sale of
goods and services.
They take borrowing from financial sector.
Payments of the producer sector:


Producer sector makes factor payments to the household sector for using the
factor services.
Saving of the producer sector goes to the financial sector
Financial/ capital sector:
Receipts of the capital sector:


Household sector makes deposit of their saving with financial sector.
Producer sector makes deposit of their saving with financial sector
Payments of the financial sector:


Financial sector gives loan to household for consumption purpose.
Financial sector gives loan to producer sector for investment purpose
National income part 2
3 sector economy with finance/ capital sector....
In a three sector economy, there are 3 sectors namely, household, producer and government sector.
Assumption of 3 sector modal:




There are 3 sectors working in an economy.
Household does not spend their entire income on the purchase of goods and services.
There is government control.
There is close economy means there is no export and import in the economy.
Explanations:
Household sector:
Receipts of the household:



Factor income from the producer sector
Transfer income from the government sector.
Borrows from financial sector.
Payments:



Household sector makes payment to the producing sector as consumption
expenditure.
The household sector makes tax payments to the government sector
Household deposit their saving with financial sector.
National income part 2
Producer sector:
Receipts of the producer sector:



Producer sector receives income from household sector and government sector
on account of its sale of goods and services.
They take borrowing from financial sector.
They take financial help from government sector in the form of subsidies.
Payments of the producer sector:



Producer sector makes factor payments to the household sector for using the
factor services.
Taxes are paid to the government sector.
Saving of the producer sector goes to the financial sector.
Government sector:
Receipt of the government sector:



Government sector receive direct taxes from the household sector.
Government sector receive indirect taxes from the producer sector.
Government sector takes borrowings from financial sector.
Payments of the government sector:



The government sector makes transfer payment to the household sector.
The government sector gives subsidies to the producer sector.
The saving of the government sector goes to financial sector.
Financial/ capital sector:
Receipts of the capital sector:



Household sector makes deposit of their saving with financial sector.
Producer sector makes deposit of their saving with financial sector.
Government sector makes deposit of their saving with financial sector.
Payments of the financial sector:



Financial sector gives loan to household for consumption purpose.
Financial sector gives loan to producer sector for investment purpose.
Financial sector gives loan to government for consumption as well as investment
purpose.
National income part 2
4 sector economy with financial sector
In a 4 sector economy, there are 4 sectors namely, household, producer, government and rest of the
world sector are involve.
Assumption of 4 sector modal:





There are 4 sectors working in an economy.
Household does not spend their entire income on the purchase of goods and services.
There is government control.
There is open economy means; there is export and import in the economy.
Household deposits their saving with finance sector and producer sector take loan from
financial sector for investment purpose. i.e. saving of the household = investment of the
producer sector.
Explanations:
Household sector:
Receipts of the household:




Factor income from the producer sector
Transfer income from the government sector.
Borrows from financial sector.
Current transfer from rest of the world.
Payments:




Household sector makes payment to the producing sector as consumption
expenditure.
The household sector makes tax payments to the government sector
Household deposit their saving with financial sector.
Current transfer to rest of the world.
National income part 2
Producer sector:
Receipts of the producer sector:




Producer sector receives income from household sector and government sector
on account of its sale of goods and services.
They take borrowing from financial sector.
They take financial help from government sector in the form of subsidies.
Export receipt from rest of the world.
Payments of the producer sector:




Producer sector makes factor payments to the household sector for using the
factor services.
Taxes are paid to the government sector.
Saving of the producer sector goes to the financial sector.
Import payments to rest of the world.
Government sector:
Receipt of the government sector:



Government sector receive direct taxes from the household sector.
Government sector receive indirect taxes from the producer sector.
Government sector takes borrowings from financial sector.
Payments of the government sector:



The government sector makes transfer payment to the household sector.
The government sector gives subsidies to the producer sector.
The saving of the government sector goes to financial sector.
Financial/ capital sector:
Receipts of the capital sector:



Household sector makes deposit of their saving with financial sector.
Producer sector makes deposit of their saving with financial sector.
Government sector makes deposit of their saving with financial sector.
Payments of the financial sector:



Financial sector gives loan to household for consumption purpose.
Financial sector gives loan to producer sector for investment purpose.
Financial sector gives loan to government for consumption as well as investment
purpose.
National income part 2
Leakage in circular flow model
These are those variables which have negative impact on the process of production in the economy.
All these variables reduce the flow of income in the economy. These are:
1)
2)
3)




Saving
Import
Taxes by the government.
Leakage in 2 sector economy……………………..No Leakage
2 with finance sector…………… Saving
3 with finance sector…………… Saving and tax
4 with finance sector…………… saving, tax and import.
Injections in the circular flow model
These are those variables which cause an expansion in the process of production in the economy.
Basically these are expenditure variables- expenditure on the goods and services producing in the
economy. These are:
1) Investment
2) Export
3) Consumption expenditure.
 injection in 2 sector economy……………………..No injection
 injection in 2 with finance sector…………… investment
 3 with finance sector…………… investment and subsidies
 4 with finance sector…………… investment, subsidies and export
National income part 2