Class 12 Macroeconomics

Circular flow  It refers to the cycle of generation of

of income income in the production process, its
distribution among the factors of
production and finally its
Production Phase circulation from households to the
(Generation of Income
firms in the form of consumption
expenditure on goods and services
Expenditure produced by them.
Income Phase
Phase
(Disposition
(Distribution  There are three different phases
of Income)
of Income) (generation, distribution and
disposition) in circular flow of
income.
 Three Different Phases of Circular Flow
Generation phase (Production) :
In this phase, firms produce goods and services with help of factor
services.
Distribution phase (Income) :
This phase involves the flow of factor income (rent, wages, interest
and profit) from firms to households.

Disposition phase (Expenditure) :

In this phase, the income received by the
factors of production, is spent on the goods
and services produced by firms.
Stock
 Stock variable refers to that variable, which is measured
at a particular point of time.
 For example, stock of goods in the godown as on 31st
January, 2023. It means, stock variable is not time
dimensional. Some more examples of stock variables are
national wealth, national capital, money supply etc. Flow

Flow
 Flow variable refers to that variable, which is measured
over a period of time.
 For example, production of goods during the month of Stock
January 2023, birth rate in the year 2022, national
income in the year 2022 are flow variables. The ‘period
of time’ could be a day, a week, a year, etc.
The difference between Stock and Flow is as follows :
Basis Stock Flow
Stock variable refer to that Flow variable refer to that variable,
Meaning variable, which is measured at a which is measured over a period of
particular point of time. time.
It has a time dimension as its
Time
It does not have a time dimension. magnitude can be measured over a
Dimension
period of time
Nature of
It is a static concept. It is a dynamic concept.
Concept

• Population of India as on 31.03.22. • Number of births during 2022.

• Total number of Maruti cars in • Maruti cars manufactured during
Delhi. January, 2023.
Example • Money supply (money in • Expenditure or transactions in
circulation). money.
• National wealth. • National income.
• Quantity of wheat stored. • Quantity of wheat produced.
 There are two types of
Circular Flow

Real Money
Flow Flow
Real Flow
 Real flow refers to the flow of factor services from households to firms and
the corresponding flow of goods and services from firms to households.
 There is an exchange of goods and services only between the two sectors
without the involvement of any money.
 It is also known as ‘Physical flow’.
 There may be difficulties with the barter system of exchange of goods and
services.
 Real flow determines the magnitude of the growth process in an economy.

Money Flow
 Money flow refers to the flow of factor payments from firms to households
for their factor services and the corresponding flow of consumption
expenditure from households to firms for the purchase of goods and
services produced by the firms.
 It involves an exchange of money between the two sectors.
 It is also known as ‘Nominal flow’.
The difference between Real Flow and Money Flow is as follows :
Basis Real Flow Money Flow
It is the flow of goods It is the flow of money
Meaning and services between between firms and
firms and households. households.
Kind of It involves an exchange It involves the
Exchange of goods and services. exchange of money.
There may be difficulties
There is no such
Difficulty in of a barter system in the
difficulty in the case
Exchange exchange of goods and
of money flow.
factor services.
Alternative It is also known as It is also known as
Name Physical flow. Nominal flow
The four major sectors in an economy according to the macroeconomic point of view are :

Household It includes consumers of goods and services and also the owners of factors of production.
They supply factors like land, labour, capital and entrepreneur and receive income in
Sector return in the form of rent, wages, interest and profit respectively.

Producing It includes all producing firms in the economy. To produce goods and services, the firm
hires factors of production from the households. Households consume goods and services
Sector (Firms) to satisfy their wants and firms produce goods and services to make a profit.

It acts in two capacities :

Government  As a welfare agency, it is involved in maintaining law
and order, defence and other services of public welfare.
Sector  As a producer, it produces goods and services in public sector enterprises.

Foreign Sector
This sector includes transactions with the rest of the world. It is involved in the
(Or External Sector or
export and import of goods and the flow of capital between the domestic
Rest of the World
economy and other countries of the world.
Sector)
Circular Flow in a  A simple economy assumes the
Simple Economy existence of only two sectors, i.e.,
(Two-sector household sector and the firm sector.
Economy)
a) Households are the owners of
factors of production and
consumers of goods and services.
b) Firms produce goods and services
and sell them to households.
 It is the simplest form of closed
economy, in which there is no
government sector and foreign
trade.
  There are only 2 sectors in the economy :
Assumptions Households and Firms. It means, there is
no government and foreign sector.
 The household sector supplies factor
services only to firms and the firms hire
factor services only from households.
 Firms produce goods and services and sell
their entire output to households.
 Households receive factor income for their
services and spend the entire amount on
the consumption of goods and services.
 There are no savings in the economy, i.e.,
neither the households save from their
incomes, nor the firms save their profits.
The Circular Flow in Two- Sector Economy can be Understood with
the Help of Diagram given below :

Factor Services The outer loop of the diagram shows

(Land, Labour, Capital and Enterprise)
the real flow, i.e. flow of factor
services from households to firms and
Consumption Expenditure
the corresponding flow of goods and
(On Goods and Services)
services from firms to households.

Households Firms The inner loop shows the money

flow, i.e. flow of factor payments
Factor Payments from firms to households and the
(Rent, Wages, Interest and Profit)
corresponding flow of consumption
expenditure from households to
Goods and Services
firms.
In a Two-Sector Economy, the following conclusions can
be drawn :
Total production of goods and services by Firms is equal to
Total consumption of goods and services by Households.

Factor payment by Firms is equal to Factor Income of

Households.

Real flow in the form of factor services and final goods and
services is equal to Money Flow between firms and households.

Consumption expenditure by Households is equal to

Factor income of Households.