National Income
Meaning
Total market value of the final goods and
services produced in an economy in a
year
CIRCULAR FLOW OF INCOME
AND PRODUCT
Pictorial illustration of Interrelation of
economic activity
Involves two kinds of flows
Money flows
Real flows (flow of Goods and Services)
Aspects of Circular Flow of N.I.
Real Flow Money Flow
Movement of Factor services Movement of money as
from household to firms payment for factor services
from firms to households
Movement of Goods &
Services from firms to Movement of money as
Households payment for goods & services
from household to firms
CIRCULAR FLOW OF INCOME
AND PRODUCT
Open
ClosedEconomy
Economy
Four sector model
Two sector model
Households
Households
Firms
Firms
Government
Three sector model
Rest of the world
Inclusion of Government Sector
Savings Investment
Capital Market
TWO SECTOR MODEL
WITHOUT SAVINGS
Two sectors – Households and Firms
Households spend their entire income on consumption (Y=C)
Savings=Zero as Y=C+S
Firms sell all that is produced to Households
Firms spend their entire income on Rent, Wages, Interest and
Profit. There are no undistributed profits.
There are no leakages and injections - Circular flow of
Income remains constant
Such an economy has two types of markets
Product Market for Goods and services
Factor Market for Factors of Production
TWO SECTOR MODEL WITH
SAVINGS
Savings reduce consumption expenditure.
If households hoard a part of their income- leakage.
If households save with financial institutions who in
turn give it out as loans to firms for investment the
money is injected back into the economy.
Households are Net Savers while Firms are Net
Borrowers
If S > I, Income flow will decline as
Leakage>Injection
If S < I, Income flow will increase.
TWO SECTOR MODEL WITH SAVINGS
THREE SECTOR MODEL
Three sectors- Firms, Households and Government
Government earns revenue from taxes (T) which includes
Personal taxes on Households (T1)
Corporation tax on Firms (T2)
T= T1 + T2
Govt. spends this revenue on
Payment made to Households for services (G1)
Purchasing goods from Firms (G2)
Making Transfer Payments to Households (G3)
Giving Subsidies to Firms (G4)
G= G1+ G2 + G3 + G4
THREE SECTOR MODEL
Firms may have undistributed profits (retained
earnings) to be used for investment
This implies that the PY of the HH < NY of
the country
If the Government has a Deficit in the Budget
(G > T) it will borrow from the Financial
System
Conversely it will save if it has a Surplus in
the Budget (G < T)
THREE SECTOR MODEL
K
market
FOUR SECTOR MODEL
OPEN ECONOMY
Inclusion of “Rest Of the World”
Imports (M) cause an outflow of Income -
Leakage
Exports (X) cause an inflow of Income -
Injection
Factor Income to abroad (P) will cause the
circular flow of income to decline – Leakage
Factor Income from abroad (R) will cause the
circular flow of income to rise – Injection
OPEN ECONOMY
GOVT
TAXES
4
G
Taxes
+
S B
2
G1
G
+G
3
FINANCIAL SYSTEM
HH S B FIRMS
CONSUMPTION EXP.
FACTOR PAYMENTS
P
FO
In
X
t.
d
or
In Pay
an
Fa
tf
t. m
ct
M
Tr en
en
or
an ts
or
In ym
tf
sfe
Pa
co
en
r
ym
e ROW
Pa
RELATION BETWEEN
LEAKAGES AND INJECTIONS
INJECTIONS
LEAKAGES
Savings (S) (I)
Investments
Taxes (T) Expenditure (G)
Government
Imports (X)
Exports (M)
International Factor Income from
to abroad
abroad
International Transfer Payments from
to abroad
abroad
For stability in the Circular
Flow of Income
Leakages = Injections
