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Handouts on

UNIT – I : NATIONAL INCOME AND RELATED

AGGREGATES

CHAPTER - 1.
CIRCULAR FLOW OF INCOME
CBSE EXPECTED WEIGHTAGE = 4 MARKS
 THEORIES = 1 QUESTION OF 1 MARK EACH = 1 MARK
1 QUESTION OF 3 MARKS EACH = 3 MARKS

INDEX
S.No. Topics Page No.
1. Meaning of Circular Flow of Income CFI 2
2. Phases of Circular Flow of Income CFI 2
3. Stock and Flow CFI 3
4. Types of Circular Flow CFI 4
5. Circular Flow in a Simple Economy (Two- CFI 5
Sector Economy)
6. Leakages and Injections CFI 6
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1. Meaning of Circular Flow  It refers to
of Income  cycle of generation of income in the production
process,
 its distribution and finally,
 its circulation from households to firms in the form of
consumption expenditure on goods and services
produced by them.

2. Phases of Circular Flow  Generation Phase – In this phase, firms produce goods and
of Income services with the help of factor services.
 Distribution Phase – This phase involves the flow of factor
income (rent, wages, interest and profit) from firms to the
households.
 Disposition Phase – In this phase, the income received by
factors of production, is spent on the goods and services
produced by firms.

CFI 2
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3. Stock and Flow 1. What are stock variables? (CBSE D 2012, 2016, AI P P
2011) r r
2. Define flow variable. (CBSE 2011, AI 2012, 2016) o o
3. Distinguish between stocks and flows. Give an f f
example of each. (CBSE AI 2013, F 2010) i i
4. Which of the following is not a flow? (CBSE D C t t
2015)
(a) Capital. (c) Investment & &
(b) Income (d) Depreciation
5. Which of the following is a stock? (CBSE AI C 2015) L L
(a) Wealth. (c) Saving o o
(b) Exports (d) Profits s s
6. Which of the following is a flow? (CBSE D C 2016) s s
(a) Deposits in a bank (c) Capital
(b) Depreciation. (d) Wealth A A
7. Which of the following is a stock? (CBSE AI C 2016) / p
(a) Savings c r
(b) Consumption of fixed capital .
(c) Production
(d) Capital. A
8. Flow of goods and services and factors of production /
across different sectors in a barter economy is c
known as: (CBSE Sample Paper 2016)
(a) Circular Flow (c) Monetary Flow
(b) Real Flow. (d) Capital Flow

Examples for Better Clarity

 The amount of water in tank is the quantity of water in the
tank at a given point of time. On the other hand, water
flowing into the tank from a tap is a flow of water being
added to the tank per unit of time.
 The total number of houses as on December 31, 2019 is the
stock concept, while the number of houses constructed
during the year 2019 is a variable flow.

CFI 3
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Difference Between Stock and Flow

Basis Stock Flow
Meaning Stock variable Flow variable refers to
refers to that that variable, which is
variable, which is measured over a period
measured at a of time.
particular point of
time.
Time It does not have a It has a time dimension
Dimension time dimension. as its magnitude can be
measured over a period
of time.
Nature of It is a static It is a dynamic concept.
Concept concept.
Examples 1. National Wealth 1. Losses
2. Balance in a bank 2. Profit
account 3. Savings
4. National income of a
country
5. Production
4. Types of Circular Flow 1. Distinguish between Real flow and Money Flow.
(CBSE D 2003)

There are two types of circular flows:

(i) Real Flow, and
(ii) Money Flow.
Difference Between Real Flow and Money Flow
Basis Real Flow Money Flow
Meaning It is the flow goods It is the flow of money
and services between between firms and

CFI 4
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firms and households. households
Kind of It involves exchange of It involves exchange of
Exchange goods and services. money.
Difficulty There may be There is no such
in difficulties of barter difficulty in case of
Exchange
system in exchange of money flow.
goods and factor
services.
Alternative It is also known as It is also known as
Name Physical Flow. Nominal Flow.
Diagram

5. Circular Flow in a Simple 1. Explain the circular flow of income. (CBSE, D 2003,
Economy (Two-Sector 2009, 2013, D C 2014, 2015, AI C 2016)
Economy)
A simple economy assumes the existence of only two sectors,
i.e. household sector and firm sector.

 Households are the owners of factors of production and

consumers of goods and services.
 Firms produce goods and services and sell them to the
households.

In order to make our analysis simple, we take our assumptions:

1. There are only 2 sectors in the economy: Households and
Firms. It means, there is no government and foreign sector.
2. Household sector supplies factor services only to firms and
the firms hire factor services only from households.
3. Firms produce goods and services and sell their entire
output to the households.
4. Households receive factor income for their services and
spend the entire amount on consumption of goods and
services.
5. There are no savings in the economy, i.e. neither the
households save from their incomes, nor the firms save
from their profits.

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 The outer loop of diagram shows the real flow, i.e. flow
of factor services from households to firms and
corresponding flow of goods and services from firms to
households.
 The inner loop shows the money flow i.e., flow of factor
payments from firms to households and the
corresponding flow of consumption expenditure from
households to firms.

6. Leakages and Injections Differences Between Leakages and Injections

Basis Leakages Injections
Meaning These refer to These refer to
withdrawal of the introduction
money from the of income into the
circular flow. circular flow.
Impact on When households When households
Circular Flow of and firms save a and firms borrow
Income part of their money from
incomes, it leads external sources
to a leakage from like financial
the circular floe institutions, it
of income. So, adds to the
leakages reduce circular flow of
the flow of income. So,
income. injections increase
the flow of

CFI 6
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income.
Examples of 1. Two-sector 1. Two-sector
Leakages in economy economy
Different Types (without (without
of Economies Financial Financial
Market) = No Market) = No
Leakage Injection
2. Two-sector 2. Two-sector
economy (with economy (with
Financial Financial
Market) = Market) =
Savings Investment
Note: Equilibrium is achieved when Injections are equal to
Leakages.

END OF NOTES

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