NATIONAL INCOME & CIRCULAR FLOW OF

INCOME

CLASS – XII

It is regarded as the most

comprehensive measure of the

level of economic activity and

index of economic growth of an

economy.

National Income

It is defined as the value of all final

goods and services produced by the

normal residents of a country,

whether operating within the

domestic territory of the country or

outside, in a year.

What is National Income?

Money – Common Denominator

We can assign monetary value in terms

of market prices or in terms of factor

costs.

Monetary Expression

These are sold to the final users during the

year.

Finished goods for

final consumption and investment.

Final goods and services:

◦ Food items, refrigerators etc. – consumption

◦ Machines, buildings etc. - Investment

Final Goods & Services

These are used by the producers as

input into a further stage of

production.

Resold after converting into final

goods.

Seeds, fertilizers, etc.

Intermediate Products

All goods and services produced during a

year must be counted once, but not more

than once.

Intermediate products are excluded from NI.

i.e. flour mills sell flour to bakeries, and

bakeries use this flour in making breads

which are sold to households…

To measure NI accurately…

NI is a flow concept. It is the flow of goods

and services. A flow is a quantity which is

measured over a period of time.

It tells us how many rupees worth of goods

and services are flowing in the economy per

unit of time.

Conventionally, NI is expressed over one

year.

Flow

NI measures the value of currently produced

goods and services.

Excludes ‘pure exchange transactions’, such

as sale and purchase of second hand goods

or used goods, purchase and sale of

securities and transfer payments. Why?

Because, nothing new is produced in the

current year.

Current Output

What to do with the value of the services of the commission agents involved in the second hand sales?

Regarding sale and purchase of financial assets (both old and new) like bonds and shares?

Services of the share brokers? Transfer payments like social security

payments (pensions, etc.), donations and gifts (unilateral payments).

Current Output

Those persons who ordinarily reside in a country which they live and whose economic interest lies in that country.

May or may not be the citizens of that country, i.e. normal residents include national, as well as foreign nationals.

They produce goods and services by selling their factor services to production units located within and outside the domestic territory of a country.

Normal Residents

Geographical or political boundary excluding foreign embassies and international institutions located within the geographical territory, and including the embassies of this country located outside its geographical territory.

Domestic product: value o final goods and services + NFI received from abroad

NI is not the sum total of personal incomes

Domestic Territory

Interaction and inter-dependence between various economic activities like production, exchange and consumption is called the circular flow of income.

NI is a flow concept. Production give rise to Income which gives

rise to Consumption/Expenditure and expenditure gives rise to income again.

It goes on continuously and indefinitely in a circular way; it has neither any beginning nor any end.

Circular Flow of Income

Thus, CFI is defined as the flow of payments and receipts for goods and services and factor services between different sectors of the economy.

Flows:◦Real Flows Flow of factor services Flow of goods and services

◦Money Flows

Circular Flow of Income

1. Production1. Production 2. Income2. Income

3. Expenditure3. Expenditure

THREE PHASES OF CIRCULAR FLOW

Involvement of Different Sectors in Circular Flow

1. The Producing Sector 2. The Household Sector

3. The Government Sector 4. Rest of the World Sector

Households / Resources (Factors of Production)

LAND LABOUR

CAPITAL ENTREPRENE

UR

Producers/ FirmsProducers/ Firms HouseholdsHouseholds

Circular Flow Model in 2 Sector Economy (Closed Economy)

1Factor Services (Real Flow)

3Goods & Services (Real Flow)

2

Factor Payments (Money Flow)

4

Consumption Expenditure (Money Flow)

Producers/ FirmsProducers/ Firms HouseholdsHouseholds

2 Sector Model with Savings/Financial System

Goods & Services (Real Flow)

Factor Services (Real Flow)

Money / Finance

SavingBorrowing for

Investment

Factor Payments (Money Flow)

Consumption Expenditure (Money Flow)

ProducersProducers HouseholdsHouseholds

The Circular Flow Model in 3 Sector Economy

Money / Finance

Saving

Borrowing

Transfer Payments

Consumption Expenditure

GovernmentGovernment

Taxes

Expenditure on Goods & Services

Taxes

Borrowing

SavingS

avin

g

Bo

rro

win

g

Subsidies

Factor Payments

ProducersProducers HouseholdsHouseholds

The Circular Flow Model in 4 Sector Economy (Open Economy)

Money / Finance

Saving

Borrowing

GovernmentGovernment

Borrowing

Saving

Govt. Consumption Expenditure

Transfer Payments

Taxes

Transfer

Pay

men

ts

Taxes

Borrowing

SavingRest of the WorldRest of the WorldExp

ort

R

eceip

t

Imp

ort

Paym

ent

Net Transfer

Payments

Net Factor Payments

Flow Variables which have negative impact on the process of production in the economy.

Leakages in the Circular Flow

Savings [S]

1

Taxes [T]

2

Imports [M]

3

Flow Variables which cause expansion in the process of production in the economy.

Injections in the Circular Flow

Investment [I]

1

Govt. Consumption Expenditure [G]

2 3

Exports [X]

Investment (I)Investment (I)

Governmentexpenditure (G)

Governmentexpenditure (G)

Exportexpenditure (X)

Exportexpenditure (X)

BANKS, etc

Netsaving (S)

Netsaving (S)

GOV.

Nettaxes (T)

Nettaxes (T)

ABROAD

Importexpenditure (M)

Importexpenditure (M)

The circular flow of incomeThe circular flow of income

Leakages

INJECTIONS

Consumption of domestically

produced goods &

services (Cd)

Factor Payments

2.Innovative Technology both in the areas of Production and Management

Circularity Never Stops…

1. The discovery of new resources

Knowledge of Interdependence

Identification of Injections &

Leakages

Estimation of National Income

Level and Structure of Economic

Activity

Significance of the Study of Circular Flow of Income

Its Quiz Time….State following sentences whether true of false

Economy is broadly classified into two sectors

Production refers to ‘Value Addition’

2-sector model of economy is also known as Open

Economy

Triplet Identity in circular flow is;

Production=Income=Expenditure

Money flows are opposite to real flows in circular

flow

Circularity stops when leakages are there in

system

Thank You