Our Business Studies Notes
Part A – Principles and Functions of Management
Part B – Business Finance and Marketing
1. Meaning
The circular flow of income describes the continuous cycle where households provide factor services to firms and, in return, receive factor incomes—rent, wages, interest, and profit. Households then use this income to purchase goods and services produced by firms, completing the cycle. This cycle continues, driving the economy forward.Â
2. Three Phases of Circular Flow
Sandeep Garg breaks down the process into three distinct phases:
Generation Phase: Firms use factor services from households to produce goods and services.
Distribution Phase: Firms distribute factor incomes—wages, rent, interest, profit—to households.
Disposition Phase: Households spend this income on goods and services produced by firms, completing the flow.Â
3. Stock vs. Flow
Stock variables are static and measured at a point in time (e.g., population, national wealth).
Flow variables are dynamic and measured over a period (e.g., national income, production).Â
4. Types of Flow: Real vs. Money
Real Flow (Physical Flow): The movement of factor services (from households to firms) and goods/services (from firms to households).
Money Flow (Nominal Flow): The flow of factor payments (from firms to households) and consumption expenditure (from households to firms).
5. Two-Sector Model
The simplest model comprises only households and firms.
Assumes no savings—households spend all income on consumption.
Real flow forms the outer loop; money flow forms the inner loop.
This mutual dependence sustains the circular flow in a continuous loop.Â
6. Beyond the Two-Sector Model (Overview)
While Sandeep Garg primarily emphasizes the two-sector framework, the broader circular flow concept extends to:
Three-Sector Model: Adds the government—incorporating taxation, government spending, and transfers.
Four-Sector Model: Adds the foreign sector, introducing exports (injections) and imports (leakages).
7. Leakages and Injections
Leakages: Withdrawals such as savings, taxes, and imports.
Injections: Additions like investments, government spending, and exports.
Equilibrium in the economy is achieved when total leakages equal total injections.
Summary Table
| Component | Details |
|---|---|
| Meaning | Income circulates continuously between firms and households |
| Phases | Generation → Distribution → Disposition |
| Stock vs. Flow | Stock = at a point; Flow = over a period |
| Flow Types | Real (goods/services) vs. Money (payments/expenditures) |
| Two-Sector Model | Households + Firms; no savings; simple circular loop |
| Higher Models | Government and foreign sectors introduce complexity |
| Leakages & Injections | Savings, taxes, imports vs. investments, spending, exports |