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Circular Flow Of Income and its principles| Two- Sector Economy and Three Sector Economy| Economics 12th class

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Before You know what is 2 sector and 3 sectors economy and how income flows on these sectors, let me give you a brief about what is the circular flow of Income?

The flow of production, income & expenditure is a circular flow. The production gives rise to income, income gives rise to a demand for good and services and demand in return gives rise to expenditure. Expenditure leads to further production. Thus, the flow of production, income and expenditure becomes circular with no beginning or no end. 

circular flow of income, circular flow, production, expenditure, income flow

Principles of the circular flow of income and product 

. Real Flow ( in terms of goods& services) is opposite to the money flow.

. A flow of income across different sectors always implies the identity between payments and receipts.

The circular flow of income in a two-sector economy


circular flow- two sector economy

1. The household sector provides factor services in the form of land, labour, capital etc to the producing sector. The producing sector provides good and services to the household sector.

2. When only goods and services flow from one sector to the other sector, it is called real flow (Blue arrows in the above diagram).

3. When the household sector provides factor services to the producing sector, it makes payments in the form of rent, wages etc which becomes the income of the household sector. Likewise, when producing sector provides good and services to the household sector, it spent on goods and services which becomes the income of producing sector.

4. When money flows from one sector to another sector, it is called monetary flow (Grey Arrows in the above diagram).

The circular flow of income in a two-sector economy with the help of Financial Institution (FI)


In the modern economy, FI plays an important role. The household sector and producing sector save a part of their income and deposit in the financial institutions. Not only these, at times they require a loan and thus borrow from these institutions.

circular flow of income

The circular flow of income in a three-sector economy


1. The third sector is the government sector. The household sector and the producing sector give taxes to the government sector.

2. The government sector provides transfer payments to the household sectors. Transfer payments are one-sided payments from the government to the household sector. e.g old age pensions, scholarships, unemployment allowances etc.

3. The government sector provides subsidies to the producing sector.  Subsidies are help given by the government to the producing sector in the form of raw material, money etc.

4. The household sector provides factor services to the government sector in return to which they make factor payments.

5. The producing sector provides goods and services to the government sector which in return spends on goods and services.

 

 

 

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