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services produced in the economy are Firms, Government and Foreign sector)
considered. The value of intermediate goods Y = C + I + G + (X-M)
or raw materials is not considered. For The circular flow of goods and money in a
example, while estimating the production two sector model is explained below :
of shirts, there is no need to take the value Two sector model of Circular flow of National
of cotton, as it is already included in the Income :
price of the shirts. There are two sectors, households and
3) Net aggregate value : National income firms. It divides the diagram into two parts. The
includes net value of goods and services upper half represents the factor market and the
produced and does not include depreciation lower half represents the commodity market.
cost. (i.e. wear and tear of capital assets) Fig. no. 7.2 explaines circular flow of
4) Net income from abroad : National income and expenditure in a two sector model.
income includes net income from abroad i.e. Land, Labour, Capital and Enterprise
difference between export value and import
value (X-M) and net difference between Consumption Expenditure on
receipts from abroad and payments made Goods and Services
abroad (R-P).
5) Financial year : National income is always Households Firms
expressed with reference to a time period.
Factor Income, Rent,
In India, it is from 1st April to 31st March. Wages, Interest, Profit
6) Flow concept : National income is a flow
concept as it shows flow of goods and Flow of Goods and Services
services produced in the economy during a Fig. 7.2
year. In the above figure 7.2, the factors of
7) Money value : National income is always production flow from the households to the
expressed in monetary terms. It represents firms. The firms use these factors to produce
only those goods and services which are goods and services required by the households.
exchanged for money. Thus, goods flow from the households to the
firms and from the firms back to the households.
Circular Flow of National Income : It is called product flows.
Circular flow of income is the basic concept In the same way, money flows from the
in macro economics. The circular flow of income firms to the households in the form of factor
refers to the process whereby an economy's payments such as rent, wages, interest and
money receipts and payments flow in a circular profit. Households use this income to purchase
manner continuously through time.
goods and services. Thus, money flows from the
Circular flow of income can be determined firms to the households and from the households
for the following :
back to the firms. It is called money flows.
1) Two sector Economy (Households and In the circular flow of income, production
Business Firms.) Y = C + I generates factor income, which is converted
2) Three sector Economy (Households, into expenditure. This flow of income continues
Business Firms and Government sector) as production is a continuous activity due to
Y = C + I + G never ending human wants. It makes the flow of
3) Four Sector Economy (Households, Business income circular
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