Circular Flow of Income Diagram

The Circular flow of income diagram models what happens in a very basic economy.
Circular Flow of Income

 

In the very.basic model, we have  two principal components of the economy:

  1. Firms. Companies who pay wages to workers and produce output.
  2. Households. Individuals who consume goods and receive wages from firms.

 

This circular flow of income also shows the three different ways that National Income is calculated.

  1. National Output. Output  produced by firms.
  2. National Income. The total income received by people in the economy. For example, firms have to pay workers to produce the output. Therefore income flows from firms to households.
  3. National Expenditure. Total amount spent on goods and services. For example, with wages from work, households can then buy goods produced by firms. Therefore, the spending goes back to firms.

This represents a simple economic model; it is a closed economy without any government intervention.

In the real world it is more complicated. We also add two more components:

  1. Government. The government taxes firms and consumers, and then spends money, e.g. health care and education.
  2. Foreign sector. We sell exports abroad and buy imports. Therefore, there is a flow of money between one country and the rest of the world.

 

 

Withdrawals (W) into Circular Flow of Income

Withdrawals are items that take money out of the circular flow. This includes:

  • Savings (S) (money not used to finance consumption, e.g. saved in a bank)
  • Imports (M) (money sent abroad to buy foreign goods)
  • Taxes (T) (money collected by government, e.g. income tax and VAT)

Injections (J) into Circular Flow of Income

Spending that puts money into the circular flow of income.

  • Investment (I). Money invested by firms into purchasing capital stock.
  • Exports (X). Money coming from abroad to buy domestically produced goods.
  • Government spending (G). Government welfare benefits, spending on infrastructure.

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43 Responses to Circular Flow of Income Diagram

  1. Ayesha butt April 19, 2011 at 8:16 pm #

    i learned many things form this site about economics.

  2. IME August 3, 2011 at 1:15 pm #

    it ok but,i need more info on it. Tanks

  3. mayuri September 9, 2011 at 6:22 pm #

    thanks for the diagram…………………………..

  4. Dheeraj choudhary September 17, 2011 at 6:40 pm #

    thanks for the diagram but i need more

  5. thax 4 d dragram September 22, 2011 at 9:21 am #

    i need more of d dragram

  6. oscar September 29, 2011 at 11:14 am #

    more diagram please.well, thanks.

  7. chiedza February 18, 2012 at 4:05 pm #

    thanks for the diagram it really helps…..:)

  8. Imran Ahmed May 28, 2012 at 1:44 pm #

    thanks!

  9. Ahmad Milad Ghawsi December 2, 2012 at 7:08 am #

    thanks i learned alot but more is needed.

  10. chameli akter March 10, 2013 at 3:42 pm #

    I would like to know …….. circular flow of national income in three sector of economy . Please u submit this topics

  11. Manisha March 14, 2013 at 8:39 am #

    I learnt a lot from this site. Thanks for such a clear and concise explanation.