Cyclic Flow of Income

The main economic activities in an economy are Production, Consumption and Distribution. Through these activities, income, expenditure and the economy are created. These activities also influence the relationship and interdependence of various sectors in the economy. The cyclical flow of income also explains the interrelationship of various sectors in a diagram. In a two-sector economy, there is a cyclical flow of production, income and expenditure.

Imagine that there are two sectors in the economy, namely the Household sector and firms. The household sector is the sector that provides the services of factors of production such as land, labor, capital and organization to the production sector. The production sector is the sector that produces with the help of factors of production. The household sector spends all its income on its consumption. The production sector sells all its products to the household sector.

It shows the redistribution of income in a circular manner between the production unit and households. There are basically four types of remuneration that are paid during the production of goods and services. These are land, labor, capital, and entrepreneurship

■ Rent - The remuneration for the contribution made by fixed natural resources (called land) is called rent.

■ Wage - The remuneration for the contribution made by a human worker (called labor) is called wage.

■ Interest - The remuneration for the contribution made by capital is called interest.

■ Profit - The remuneration for the contribution made by entrepreneurship is called profit.

Types of Cyclic Flow of Income

There are two types of cyclical flows.

1. Money Flow

The flow of money from firms to households and from households to firms is known as Money Flow.

2. Real Flow

The flow of factor services from households to firms and the flow of goods and services from firms to households is known as Real Flow.

When the income received by the factors of production is used to purchase goods and services, domestic consumption equals the total cost of production. The total consumption of households is equal to the total expenditure on goods and services produced by all the firms in the economy.

Circular Flow of Income in a Simple Economy

Explanation of Diagram

■ The diagram's outer loop illustrates the flow of factor services from businesses to households as well as the flow of factor services from households to businesses.

■ The inner loop illustrates how goods and services go from businesses to homes as well as how consumers spend their money on goods and services.

Flow and Stock

Flow - In economics, some variables are defined on the basis of a certain period of time. Those that can be measured and quantified over a certain period of time are called flows. Flows are those that occur within a certain time frame. Example - Income, production, profit, losses etc.

Stocks - Stocks are those that can be measured and quantified at a certain point in time. Example - A person's bank deposits, wealth, etc. on 01.01.2025, capital, population