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Circular Flows Of Income

All economic activities begin with the organization of production process.

Four factor inputs, viz., (i) land, (ii) labour, (iii) capital, and (iv) enterprise join hands. The suppliers of factor inputs are known as households. The organizers of production activities are known as firms.

The households supply their factor services to the firm; firms pay them a price these services.

Payment received from the firms constitutes the income of the households.
Households make use of this income to purchase different goods and services produced by the firms.

Thus, income leads to consumption, and consumption, in turn, induces more production. The process keeps on continuously repeating itself. This is what we call the circular flow of income.

The different stages in which this circular flow operates can briefly illustrated follows with the help.

1.    Households supply factor services to the firms. (1)

2.    Firms make payments for factor services in the form of rent, wages, interest and profits. (2)

3.    Households make use of the income received from firms to purchase different goods and services for their own consumption. Thus, consumption expenditure flows from households to firms. (3)

4.    In return fro this expenditure, households receive different foods and services from the firms.

Thus, organization of production process results in-
•    employment for factor services,
•    generation of income for factor services,
•    Production of different types of goods and services, and
•    Consumption of different goods and services.

 It is a continuous, ongoing, never ending process.
The circular flow of income involves two basic principles:

•    In any exchange process, the seller or producer receives the same amount that the buyer or consumer spends.

•    Goods and services flow in one directing. Money payments to acquire these goods and services flow in the return direction, thereby causing a circular flow.

The output or product or real flow from the seller to the buyer necessarily creates income or payment or money flow from the buyer to the seller.

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