Class 12 Economics Circular Flow of Income – Introduction, Types & Importance

Class 12 Economics Circular Flow of Income

Class 12 Economics Circular Flow of Income – Introduction, Types & Importance

The circular flow of Income alludes to the progression of cash, administrations, and products, and so on. This flow occurs as far as pay in the creation procedure, appropriation between the variables of creation, and toward the end the dissemination of the item from family unit to a firm as utilization use on merchandise and ventures made by them.

The three different phases in the circular flow of income are:

Generation Phase – In this stage, the firm makes the products and enterprises with the help of factor administrations.

Distribution Phase – This stage includes the progression of factor salary, which involves lease, interests, wages, and benefit from firm to the family.

Disposition Phase – Here, the pay gathered by the variables of creation, is utilized on the products and ventures made by a firm.

Class 12 Economics Circular Flow of Income & Types of Markets

Before moving ahead to understand the Types of Circular Flow on Income, let’s first understand about the types of Markets taken in the circular flow of income;

Browse the video and learn types of Circular Flow of Income


There are two types of markets in the circular flow of goods and services. The asset showcase is the place organizations buy what they use to deliver merchandise and ventures. Assets are as work, common assets, capital, and business enterprise, which are all provided by family units.

On the off chance, for instance, a business needs to assemble a little plant to deliver electronic gear; it must have land on which to fabricate the plant. During the time spent structure the plant, it utilizes human workers who thus utilize common assets to develop the structure. Funding to finish the structure comes at last from family units, ordinarily by methods for some kind of budgetary organization that loans cash to the business visionaries (who likewise originate from families) to develop the hardware plant.
Item advertises are the place products and enterprises are sold. On account of the plant that produces electronic gear, the outlets for its items may be retail locations. Individuals from families buy the gear for their own utilization in the family. Bits of electronic gear are bought by the families that additionally gave the assets that made it conceivable to fabricate the item. In the converse bearing is the progression of spending. Starting with family units, the people go through cash for the acquisition of merchandise and enterprises that are given by organizations. In our model, the buy is of a completed bit of electronic hardware. The cash that is spent on the gear streams from family units to the business, making it workable for the business to support activities.

To continue activities, the business must compensate laborers and buy assets. Cash keeps on coursing through the business into the asset markets. Remember that one of the indispensable assets for the activity of a business is HR, which are provided by family units. A portion of the cash that goes through the business returns into the families as pay for the utilization of the HR. By and by, the roundabout stream is finished: cash that originated from family units through the acquisition of electronic hardware goes back to families as wages.

The money flow is broader than just wages, as appeared in Figure 1. Family units don’t burn through the entirety of their wages on products and enterprises. A portion of the cash goes into banks, monetary ventures, land, and various different spots. From those assets, family units hope to get intrigue or lease as the asset is utilized. Banks and other monetary foundations don’t just hold the cash that is kept by the family units—rather, they use it to give money to building electronic plants and for various different reasons. The cash streams to and fro through the circle.
The two progressions of pay and consumptions are equivalent. Uses on items are at last somebody’s family unit salary. Pay that streams into families is used somehow or another, either for merchandise and ventures or to buy stock in organizations, CDs, land, or another sort of venture.

1. Real Flow

  • The term Real Flow implies the progression of factor administrations from family unit to firms. Correspondingly, the progression of products and enterprises from firms to family unit.


  • These allude to the progressions of products and enterprises. These are genuine in light of the fact that they comprise of real merchandise and ventures. At the point when factor (administrations of land, work, capital, venture) stream from family to firms which require them for creating merchandise and enterprises, these are called Real flows. Likewise, when products and ventures created by firms stream from delivering undertakings to families who get them for fulfilling their needs, these are additionally Real flows. Such streams are nonstop and there is no starting point or closure point in these streams.


  • The firm part enlists beneficial or factor administrations (land, work, capital and endeavor) from the family units to create merchandise and ventures. This is real flow.


2. Money Flow

  • The Money flow alludes to the progression of factor installments from firm to family for factor administrations.


  • These allude to the progressions of cash as factor installments and utilization consumption. The cash streams happen since it is through cash that different exchanges are led. It is cash that encourages such exchanges bringing streams of cash starting with one segment then onto the next.


  • At the point when factor wages (lease, wages, premium and benefit) stream from firms to family units as remunerations for their factor benefits, these are called cash streams. Likewise, when families spend their earnings on acquisition of products and enterprises and as result cash streams back to firms, these additionally demonstrate cash streams.


  • With the cash salary consequently earned, the family units buy from firms products and enterprises like food, material, house, shoes, instructive, clinical and banking offices, and so forth for fulfilling their needs. This is genuine stream from firm segment to family unit area. Consequently, the family units make installment to the firm part as cash. This is cash stream from family units to firm area.

Class 12 Economics Circular Flow of Income & Types of Markets

The Circular flow of income is further differentiated into the following types of Models:

  • Two sectors (Households and Firm),
  • Three sectors (Households, Firm and Government) or
  • Four sectors (Households, Firm, Government and Rest of the World)



The circular flow of Income in a two sector economy comprises two types of markets, viz, the Product Market and the Factor Market. Under this flow on Income, the firm sector hires factor services from households who are owners of factors of production, such as land, labour, capital, for producing goods and services and pays them compensation in the form of money against the rendering of the productive services.

The circular flow of money between the two sectors from households to the firms can be better understood by the below diagram:

Class 12 Economics Circular Flow of Income & Types of Markets


The circular flow of Income in a three Sector Economy includes the Government Sector which purchases goods from firms and labor services from households. The flow of money between households and the government is from government to the households when the government makes transfer payments in the form of pension, scholarships, etc. and the money flows back to the government when it collects direct taxes from the households. This creates the Circular flow of income between the three sectors of Economy which is represented in the below diagram:



  • Circular Flow of Income reflects structure of an economy.
  • It shows interdependence among different sectors.
  • It gives information about injections and leakages from flow of money.
  • It helps in estimation of national income and related aggregates.



  • The circular flow model is an acknowledged method to show the progression of products and ventures in a market economy. In a blended economy, the administration assumes a significant job also, however this isn’t appeared in the roundabout stream model. Neighborhood, state, and national governments additionally produce, or cause the creation of, products and ventures. Schools, parkways, water-treatment plants, parks, and different offices are instances of government spending. Governments remove a portion of family unit wages as expenses; however they additionally infuse cash once again into families as wages. A portion of that cash returns to the administration as duties and still more goes into different spots.4


  • The administration has significant command over the economy, which thusly influences creation, work, and monetary development. In the event that loan costs go up, families will buy less products and enterprises. On the off chance that loan fees go down, family units will spend more. This spending adds to or detracts from organizations’ tasks and the measure of products and ventures being created.


  • Governments can impact the blend of merchandise and ventures offered to families. Genuine models, despite the fact that they may appear to be fairly outrageous, are the point at which the administration requested the separation of the Bell Telephone System and later of Microsoft Corporation since it was resolved that they disregarded antitrust enactment and had become restraining infrastructures. This sort of separation influences business tasks and families.

The prime finish of the circular flow model is that the general volume of the roundabout stream is to a great extent unaffected by the way taken. Specifically, family pay can be utilized for utilization, sparing, or burdens.

Now based on your understanding, try to answer following questions;

Ques 1: Which of the following is the money flow that corresponds to the real flow of resources?
factors of production
goods and services


Ques 2: An example of a government spending flow would be
transfer payments
building roads

Post your Answers, queries and feedback in the comment box below.


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July 28, 2020

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