Circular Flow of National Income :-
National income is a flow of money payments resulting from the productive resources of a country during a year. It has the concept of circular flow in this sense that the economic transactions which are made in a country during a particular year appears in different ways. The expenditure of one person is the income of another person, and his expenditure is also equal to value of goods and services. To explain this idea we assume that there is economy where are only two sectors in the economy.
2. House holds.
Firms are required to produce goods. Households own the various factors of production. Firms require the services of households to produce goods. The firms hire the services of households to produce goods. These goods are again supplied to the households. When households sector purchases the goods it makes the payments. Similarly firms make the payment in the shape of rent, wages, and interest to the households against their services.
In this way the sum of prices of the goods and services must be equal to the sum of the reward for the services of factors of production.
So income flows from firms to households in exchange for these services and again the expenditure flows from households to firms. The goods which are produced by the firms these are purchased by the household. The flow of income flows from firms to household and flow of expenditure from household to firms will be equal. This is called circular flow of national income.
We can also explain the circular flow of national income buy the following diagram :
In this diagram two circular flows are shown.
1. People provide the services and firms produce the goods and provide to the people.
2. People received reward against their services from the firms. The payments which are received by the people, these are spent on the purchase of those goods which are produced by the firms.