The Circular Flow of Income
- The circular flow of income is an economic model that illustrates money flows in an economy
- There is a simple model which shows the money flows between households and firms
- There is a more complex model which adds in other economic agents including the government, financial sector and foreign trade (net exports)
A diagram showing the simplified Circular Flow of Income between households and firms
Diagram Analysis
- Households own the wealth in the economy
- These are the factors of production
- Households supply their factors of production to firms and receive income as a reward
- They receive rent for land, wages for labour, interest for capital, and profit for enterprise
- With this income, they purchase goods/services from firms
- Firms purchase factors of production from households
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- They use these resources to produce goods/services
- They sell the goods/services to households and receive sales revenue
- National income is the value of the output of an economy over a period of time
- It can be calculated using the income approach or expenditure approach
- Expenditure = income
- Income is a flow in the economy, whereas wealth is a stock of assets that can be used to generate income
