of Income

The circular flow of income is a model of an economy showing connections between different sectors of an economy. It shows flows of income, goods and services and factors of production between economic agents such as firms, households, government and nations. The circular flow analysis is the basis of national accounts and macroeconomics. Introduction to Macro Economics Goods and services Factors for production Consumer expenditure Wages, rent, dividends Households Firms In a two-sector economy, production and sales are equal and there will be a circular flow of income and goods.

The outer circle represents real flow (factors and goods) and the inner circle represents the monetary flow (factor prices and commodity prices). Real flow indicates the factor services flow from household sector to the business sector, and in turn goods and services flow from business sector to the household. The basic identities of the two-sector economy are as under: