Circular flow of Income Circular flow of Income
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Circular flow of Income


Circular flow of income is defined as the integrated flow of resources and goods and services among the different sectors of the economy. It is a model of the economy in which the major exchanges are represented by the flow of money, goods, and services, etc. between different economic agents. It shows the interdependence between different economic activities and economic sectors.

Various economic activities such as production, distribution, consumption, etc. are carried out in an economy. During this process, different economic transactions occur in an economy which generates two kinds of flows: Flow of goods and services and flow of money. The concept of the circular flow of income is abstract and complex. Here, a simplified model of the two-sector economy is taken which consists of business and household sectors.

The concept of the circular flow of income and expenditure in a two-sector economy is based on the following assumptions:-
  1. There are only two sectors in the economy (household and business).
  2. There is no saving in the economy.
  3. There is no government expenditure and taxes.
  4. There is no international trade.
  5. Households are the owners of the factors of production.
  6. Producers purchase or hire from households.
On the basis of these assumptions, the circular flow of income and expenditure in a two-sector economy can be presented by the help of the following figure:-


The above diagram shows the circular flow of income and expenditure in the two-sector economy. The upper half of the figure represents the Product market and lower half of the figure represents the factor market. Both these markets generate two kinds of flows: Real flow and money flow.

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