Circular Flow of Income

Circular Flow of Income


The Circular Flow model is an economic model that shows the flow of major exchanges of goods & services and  Money between different sectors( Namely; Household Sector, Producer Sector(Firms), Government and Rest of the Word ) of an economy.


To present the flows of income and expenditure in a two-sector economy, the economy is divided into two sectors: (a) Household sector; (b) Firm sector.

Real Flow 

In the Real flow of two-sector model with household sectors and firms, household provides factor services to the firms and firms in return provide goods and services of the same value to households.

In REAL FLOW, the value of goods and services = value of factor services(land, labour, capital and entrepreneur )

Monetary flow (Money flow)

In Monetary flow of two-sector model with household sectors and firms.

Firms make factor payment to the household in the form of wages, rent, interest and profit against the factor services of labour, land, capital and entrepreneur to households and household spent them to purchase goods and services from firms.

In MONETARY FLOW, factor income (rent, wages, interest, profit) = payment of goods and services.

The diagram given below represents the circular flow in a two-sector economy. The upper half of the diagram shows the factor market while the lower half shows the money market and The outer circle shows the real flow and the inner circle shows the monetary flow.


Difference between Stock and Flow Variables




1.     Stock means that quantity of an economic variable which is measured at a particular point of time.

2.     The stock has no time dimension.

3.     Stock is a static concept.

4.     Examples:

a)       Wealth

b)      Water in a tank

c)       Inventories.

1.     Flow is that quantity of an economic variable which is measured during the period of time.

2.     Flow has a time dimension – like per hour per day, per month and per year.

3.     Flow is a dynamic concept.

4.     Examples:

a)     Investment

b)     Water in a stream

c)     Changes in inventories.