Principles of Circular Flow of National Income!

National income is a flow concept because it is measured over a period of time (length of time). Circular/low of income refers to continuous circular flow of money income and flow of goods between different sectors of economy.

Flow of money is the aggregate value of goods and services either as factor payment or as expenditure on goods and services.

It is circular in nature because it moves in a circle coming back to the starting point. Again it is circular because it has neither beginning nor end. How? Suppose, in an economy, there are two sectors, namely .Household Sector and Firm Sector.


The firms hire/purchase factor services from households and produce goods and services. The households as owners of factors of production (land, labour, capital and enterprise) receive the pa3mient in terms of money (rent, wages. Interest and profit) as reward for rendering production services

Thus, income is generated. The recipients of these incomes (i.e., factor owners or households) in turn spend their incomes on purchase of goods and services (produced by firms) to satisfy their wants. Expenditure by households implies income going back to firms (producers of goods and services).

This makes the circular flow of income complete. In short, income is first generated by production units, and then distributed among households (factor owners) for rendering productive services and ultimately comes back to production units (firms) by way of expenditure on goods and services by households. In this way, there is circular flow of income.

A pictorial illustration of this interdependence between major sectors of economic activity is called circular flow of Income and product.


Principles in circular flow of income:

The circular flow of income involves two basic principles:

(i) In any exchange process, the seller (or producer) receives the same amount which the buyer (or consumer) spends.

(ii) Goods and services flow in one direction and the money payment to acquire them, flow in the return direction giving rise to a circular flow. Thus, product flow from the seller to the buyer is necessarily a complement of money (income) flow from the buyer to the seller.

Real Flows and Money Flows

Income flows and product flows are equal:

The circular flows in the above diagram clearly prove that income flows in the form of factor income and consumption expenditure, and product flows in the form of factor services and final goods and services are equal.

The following conclusions can be derived from the given diagram:

(i) Total production of goods and services by Firms = Total consumption of goods and services by Household sector

(ii) Factor payments by Firms = Factor Incomes of Household sector

(iii) Consumption expenditure of Household sector = Income of Household sector

(iv) Real flows of production and consumption of Firms and Households = Money flows of Income and expen­diture of Firms and Households.