What is Circular Flow of Income

What is Circular Flow of Income. The circular flows of income refers to the flow of payments and receipts for factor services and for currently produced output passing between domestic firms and households. In other words, it describes the flow of payment from businesses to households in exchange for labour and other productive services and the return flow of payments from households to businesses in exchange for goods and services.

How to determine circular flow of income

To make discussion on circular flows of income simple, a two sector economy, which involves households and firms, will be used. The households supply factors of production (input) to firms which need them for production purposes. In return, they are paid wages, interest, rents and profits, which constitute their income. The members of the households use their incomes to purchase goods and services produced by the firms.

 This pattern of consumption expenditure made by households constitutes income for firms. This process leads to the formation of an income flow. The firms again use the income to purchase the productive service of households. Income, therefore, continues to flow in a circular flows of income. While income flows in one direction, goods  and services produced by the firms and the productive services of households flow in the other direction.


As seen in the circular flows of income and income determination theory, there are a whole lot of factors that influence the flow of income any nation. So here are a few of the factors that affect the flow of income Circular Flow of Income savings, poverty qnd wealth, resources, money

How savings influence the circular flow of income: This constitutes part of income which is not consumed immediately. They have the tendency to reduce the expenditure of the households and firms

  • Injection of funds can affect circular income flow: Injection to fund into the circle is an increase in the incomes of (2) households and firms beside their normal processes of selling productive resources and manufactured goods.
  • Taxes: Taxes tend to reduce the volume of fund in circulation as it reduces the expenditure of firms and households.
  •  Withdrawal: Withdrawal tends to reduce the amount of fund in the circular flow of income.
  • Aids and grants: Aids and grants from government or other sources increase

the volume of fund in the circular flow of income.

  •  Import and export: While imports involve expenditure on foreign made (1) goods and services leading to withdrawals from circular flow of (2) income, exports provide funds leading

to injection into the circular flow

  • How  Investment affects income flow: Investments created an (3) additional income, leading to injection

into the circular flow

163. TICK
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52. PASTURE         

Explicit costs are payment that are made for resources purchased from outside. In other words, it refers to all payments made directly for the materials used during the course of production. These costs include direct cash paid for transportation, salaries, raw materials, advertisement, etc.

Implicit cost: Implicit costs refer to the costs of the resources supplied by the owners e.g. owners of managerial skills, financial resources and owner- occupied buildings. That is, implicit cost refers to the cost wt of the firm directly incurs on production, e.g. the investor’s salary, profit and other personal expenses. As a of the involvement of some opportunity elements, these cost are usually classified as implicit.

Money cost on the other hand the amount of money spent to p: particular good or service. It can described as the money value of a co­lt is the cost in terms of legal tender (currency) value. For example, a farmer has 6100 two pressing wants, namely to buy a o a hoe, each of which costs 6100. The farmer has to choose to buy one of the items expense of the other as a result of his available resources. If the farmer decides the cutlass and forgo the hoe, N100 is thus the money cost of the cutlass he bought while opportunity cost of the cutlass is the hoe he failed to buy with the same amount of money.

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