CIRCULAR FLOW OF NATIONAL INCOME

Every year large number of goods and services are produced. These goods are produced by the firms with the help of different factors of production. There is a constant flow of factor services to the firms. In turn, firm pays to factor services in exchange of their services. The rewards that factors get in terms of money from the firms are used by them to buy goods produced by the firm. Thus, there is flow of money from factors to the firms and goods & services from the firms to the factors. This flow neither has any beginning nor any end. That is why flow of national income is called circular flow.
Circular low of income can be viewed from two different angles- 1) Real Flow of Income
                                                                                                       2)Monetary Flow of Income
                                                                                                                                       
1) Real Flow Of Income- Real flow of income implies the flow of factor services from household sector to the producing sector and flow of goods & services from the producing sector to the household sector.


                                  
2) Monetary Flow of Income- Monetary flow refers to the flow of factor income (rent, interest, profit and wages) from the producing sector to the household sector as reward for their factor services. The households spend their incomes on the goods and services produced by the producing sector. So, money flows back to the producing sector as household expenditure.
Importance of Circular Flow of Income

1)      Mutual Relation- Circular flow of income makes it clear that different sectors of economy (household sector, producing sector, government sector & rest of the world sector) are inter-dependent. Income of one sector constitutes expenditure of the other. Change in one sector has its impact on the other.

2)      Identification of Withdrawals and Injections- Circular flow model helps to identify withdrawals and injections in the economy.

3)      Estimation of National Income- National product or national expenditure can be estimated with the help of circular flow.

National Income = GDP (Gross Domestic Product) +GNP (Gross National Product) +Factor income earned by all the factor of production in the household sector
GDP= Aggregate of market value of final goods and services produced by the producing sector in a year
GNP= GDP+ Net factor income from abroad


                      

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