2. NATIONAL INCOME, OUTPUT AND EXPENDITURE
The circular flow of income
The circular flow model describes the flow of resources, products and incomes among
economic actors.
For simplicity, consider an economy with only two actors; households and firms. They
interact in a circular pattern as in the diagram below
Product
Market
Households Firms
Resource
Markets
The households
- Supply resources (land, labour, capital and entrepreneurial skills) to the
resource markets and receive earnings for those resources
- Demand goods and services from the product markets. make payments for
those goods and services using the incomes they receive
The firms
- Demand resources from the resource markets for production of goods and
services
- supply goods and services to the product markets
Products and resources flow in a counterclockwise direction while payments for these
items flow in the opposite direction
, The above case assumes an economy with no government and does not participate in
foreign trade. However, many countries trade with others and also have governments that
actively participate in the economic activities. Thus in such an economy there are 4
actors; Households, firms, government and rest of the world
Other than there being only resource and product markets there are also money markets
in the economy. a more elaborate circular flow model would therefore include all these
actors and the markets in which they interact as follows.
Rest of
M The world
I
X
G
Money C+I+G+X-M
C Market
S
Households B Firms
GNP
Disposable Government Tax
Income es
Transfers
C = Consumption expenditure G = Government purchases and Spending
S = Savings M = Imports
I = Investment spending X = Exports
B = Government borrowing
Leakages
These refer to any diversion of aggregate income from the domestic spending i.e. a
withdrawal from the circular flow. They include; Savings (S), Taxes (T), and Imports (M)
2
The circular flow of income
The circular flow model describes the flow of resources, products and incomes among
economic actors.
For simplicity, consider an economy with only two actors; households and firms. They
interact in a circular pattern as in the diagram below
Product
Market
Households Firms
Resource
Markets
The households
- Supply resources (land, labour, capital and entrepreneurial skills) to the
resource markets and receive earnings for those resources
- Demand goods and services from the product markets. make payments for
those goods and services using the incomes they receive
The firms
- Demand resources from the resource markets for production of goods and
services
- supply goods and services to the product markets
Products and resources flow in a counterclockwise direction while payments for these
items flow in the opposite direction
, The above case assumes an economy with no government and does not participate in
foreign trade. However, many countries trade with others and also have governments that
actively participate in the economic activities. Thus in such an economy there are 4
actors; Households, firms, government and rest of the world
Other than there being only resource and product markets there are also money markets
in the economy. a more elaborate circular flow model would therefore include all these
actors and the markets in which they interact as follows.
Rest of
M The world
I
X
G
Money C+I+G+X-M
C Market
S
Households B Firms
GNP
Disposable Government Tax
Income es
Transfers
C = Consumption expenditure G = Government purchases and Spending
S = Savings M = Imports
I = Investment spending X = Exports
B = Government borrowing
Leakages
These refer to any diversion of aggregate income from the domestic spending i.e. a
withdrawal from the circular flow. They include; Savings (S), Taxes (T), and Imports (M)
2
