Circular Flow of Income

INTRODUCTION

The term macro is derived from the Greek word ‘makro’, which means “large”. It is a branch of economics concerned with the description and explanation of economic processes involving aggregates. 

  • An aggregate is a collection of economic subjects that have some characteristics in common. 
  • Macroeconomics emerged after the publication of John Maynard Keynes' book, ‘The Theory of Employment, Interest, and Money’ in 1936. This branch investigates the economic relationships or issues that affect an economy as a whole, such as saving and total consumption. 
  • Macroeconomics is the part of economic theory that studies the economy as a whole, such as national income, aggregate employment, general price level, aggregate consumption, aggregate investment, etc. Its main instruments are aggregate demand and aggregate supply. It is also called the ‘Income Theory’ or ‘Employment Theory’
  • Macroeconomics is concerned with economic problems at the level of an economy as a whole. Structure of Macroeconomics implies study of different sectors of the economy.
  1. Producer sector engaged in the production of goods and services.
  2. Household sector engaged in the consumption of goods and services.
  3. Note: Households are taken as the owners of factors of production.
  4. The government sector engaged in activities like taxation and subsidies
  5. Rest of the world sector engaged in exports and imports.
  6. Financial sector (or financial system) engaged in the activity of borrowing and lending.

CIRCULAR FLOW OF INCOME

It refers to the cycle of generation of income in the production process, its distribution between the factor of production namely Land, Labour, Capital and Enterprise and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them.

Phase in Circular Flow of Income 

  1. Generation Phase: In this phase, the firm produces goods & services using factors of production (Land, Labour, capital and Enterprise).
  2. Distribution Phase: In the Second Phase, the firms make factor payments (Rent, wages, Interest & Profit) to the household for providing factor services.
  3. Disposition Phase: In this phase, the households spend the amount/income received by factors of production in purchasing good and services produced by firms.

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STOCK:

  • Stock variable refers to that variable; which is measured at a particular point of time.
  • It is static in nature, i.e., it does not change.
  • There is no time dimension in stock variables.
  • For eg. Distance, Amount of Money, National Wealth, National Capital, Money Supply, Water in Tank etc.

FLOW:

  • Flow variable refers to that variable; which is measured over a period. The ‘period of time’ could be a day, a week, a year etc.
  • It is dynamic in nature i.e. it can be changed.
  • There is time dimension in flow variables
  • For example, Speed, Spending of Money, Water in River, Exports, Imports, etc.

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