CIRCULAR FLOW OF INCOME
There is a constant flow of inputs and outputs as well as income among the different sectors of the economy, that is, the household or the personal sector and firms or the business sector. The members of households supply factors or production (inputs) to firms which require them for production purposes.
In return, they are paid wages, interest, rent and profits which constitute their incomes. The members of household use their incomes to purchase goods and service produced by a firm. This consumption from expenditure made by household constitutes income for firms. This process leads to the formation of an income cycle. The firms again use the income to purchases the productive services of household.
Income continues to move in a cycle constituting the circular flow or income. While income flows in one direction, commodities (consisting of goods and services produced by firms and the productive services of households) flows in the other direction.
Commodity And Money Flow Between Household And Firms
FACTOR AFFECTING CIRCULAR FLOW OF INCOME
- SAVING: This constitutes part of income which is not consumed immediately. If they do not spend such money on consumption it causes linkage in the system.
- INJECTION: This is an addition to the flow. Injections can be in form exports, government expenditure and investment. Increasing government expenditure creates more income for household and firms.
- AIDS AND GRANT: Income received from other countries in form of aids and grants are an addition in the circular flow. They are injections which increase the income in the flow.
- INVESTMENTS: investment creates an additional income leading injections into the circular flow of income.
- IMPORTS AND EXPORTS: While imports involve expenditure on foreign made goods and services leading to withdrawals from circular flow of income, exports provide funds leading to injections into the circular flow of income.
- TAXES: This is a form of withdrawal from the circular flow income.