Circular Flow of Income

Circular Flow of Income is a concept where get to know about that, the income and money is flowing in a circular way. The concept creates a base of economic studies. Each economic society how strategically organise their economy depends on them. The more efffectively they will strategise their economy and efficiently exploit the respurces the more growth will happen. We have discussed this concept in article of Economic Systems and their Types. The concept is driven from the concept of circular flow of income only.

In this article we are going to know about some more basic terminologies and concepts of economics along with Circular Flow of Income in center.

Four Sectors of Economy

From the economic point of view, every mixed economy is divided between four sectors.

Private Sector: All the enterprises and organisations which are not being owned by Government belongs to private sector. It can be owned by Individuals and Group of Individuals.

Government Sector: All the enterprises which are directly or indirectly owned by central government or state government comes under Government Sector. It includes: Govt. hospitals, public administration, Public Secotor Undertakings, Govt. Banks and many more.

Household Sector: A single unit of Household Sector is constituted by a group of individuals who lives together and take food from common kitchen. Basically, we can say that all the people comes under the household secotor. This is the sector from which people works in all the other sectors on different roles.

For example: Gautam Adani comes under the household sector but the Adani Group comes under the private sector. Gautam Adani works as an entrepreneur of Adani Group. Similarly, A person Vishwajeet works as a PO of State Bank of India and the Vishwajeet comes under the Household Sector but SBI comes under Government Sector.

External Sector: All the imports and exports of goods and services from one country to another country is called external sector.

We can think like a home as a country and everything that is happening under this can be distinguished between other sectors but evrything dealing with outside like purchasing anything or selling anything and other comes under the external sector.

Four Factors of Production

There are many inputs which are required to produce any output (Goods and Services). The inputs can be broadly divided into four factors of production. Any entity will require these factors of production to produce any type of goods and services.

Entrepreneur: The person who implements an idea practically and collabarates natural resources, labour and capital to generate certain output can be called as entrepreneur. Usually, in return the entrepreneur expects profit.

Capital: In this digital era capital can be termed as physical, financial and intellectual capital. But from the economic point of view the physical form of capital is considered as capital, e.g. building, machinery, equipments etc. The return for it is called Interest.

Natural Resources: It includes land and raw materials which are naturally available to us and not made by a manmade process. The return for natural resources is called Rent.

Labour: It can be divided into two types, physical labour and mental labour. Most of the buisness entity requires some type of physical or mental labour. All the people working as a employee in a firm can be termed as labour and in return they expect wages.

Types of Goods

Firstly there are two types in which we can distinguish goods.

Intermediate Good: These are the goods which are produced by a process but needs to go through a further transformation process to be converted into a final good. E.g. steel sheets

Final Good: These goods need not to be transformed again through a process it is completely ready to use and that’s why we name it final good.

Note: Depending upon different circumstances a same good can be intermediate and final. For example when a tea vendor purchases tea leaves it can be termed as intermediate good cause it is going again through the transformation process and then it is being used by people. But in another case a person is purchasing for his household uses it can be termed as final good. We can use a simple concept that the last transacted good in the market can be called final good.

Again final good can be classified into two type of goods one in consumption good and another is capital good. Goods which are consumed by the consumers can be calld consumption good.

Capital good is the type of good which is going to be used as an input for further production process. It had three charecteristic: (I) It is a produced durable output of a man made process. (II) It again acts as an input for further production process (to be sold in market). (III) While being used as an capital it is not getting transformed or completely consumed.

Investment

The part of the final ouput or GDP produced by a country which comprises physcial capital good is called the gross investment of the country. Suppose there is only one factory in a country and it is producing the worth 700 INR of consumption good and 300 INR of capital good in a year. Then the gross investment of the country is 300 INR. It is also called Gross Capital Formation.

Now, Gross Capital Formation = Gross Fixed Capital Formation + Net acquisition of valuable metals + Change in stock and inventory.

Net Investment = Gross investment – Depriciation (Weat and tear)

Cricular Flow of Income

Let’s take a hypothetical example. Suppose there is only one enterprise in an country and no external and government sector is present for now and society is not saving anything.

The enterprise is producing only 100 biscuits in a year. The enterprise will require certain inputs for production which we have discusses earlier like entrepreneur, natural resources, capital and labour.

Now it sold the 100 biscuits in 1000 Rs and they returned 200 Rs profit to entrepreneur, 100 Rs rent for natural resources, 200 Rs interest on capital and rest 500 they gave to labours. From this 1000 rupee only they will buy biscuits and consume and this circular flow will continue and economy will remain stagnant in this case. When there will be savings by individuals then company will be producing the same worth of capital good and it will create multiplier effect. We can extent this concept further for large economies.