Circular Flow of Income | Circular Flow of Income in two Sector Economy

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National income is the sum of total factor income including net factor income from abroad earned by the normal residents of a country during one year. Hi Friends, in today’s article we are going to know about Circular Flow of Income (Circular Flow of Income in two Sector Economy). So let’s discuss in details.

What is circular flow of income?

Circular Flow of Income definition – The circular flow of national income refers to the process through which the national income and expenditure of an economy flow in a circle.

In this circular the economy is divided into two groups – (i) Business Sector and (ii) Household Sector.

• Household Sector – A household consist of all individuals in a home. Households are the suppliers factors of production – land, labour, capital and organization.

Households earn income in the form of wages, rent, interest and profit from selling the factors of production to the business sector and use the income they receive to purchase goods and services supplied by firms.

• Business Sector – The business firms on the other hand, use the funds they receive from goods and services – to buy the factors of production needed to make goods and services. It is also assumed that business firms do not same.

Circular Flow of Income in two Sector Economy

Circular flow of national income in two sector economy is based on the following assumptions –

(i) It is a closed economy.

(ii) The firm sell all what they produce.

(iii) Firms make factor payments to the households as rent, wages, interest and profits.

(iv) Households do not save any part of their income.

(v) There are no government intervention in the economy.

Having specified the model, we can explained circular flow of income in two sector economy with the help of a diagram –

Circular Flow of Income | Circular Flow of Income in two Sector EconomyIn the above diagram, product market is shown in the upper portion and the factor market is shown in the lower portion.

In the product market household sector buys goods and services from the business factor, while in the factor market the household sector receives income from the business sector for providing services.

Thus the household sector purchase all goods and services provided by the business sector and make payment to the latter. The business sector intern makes payments to the household sector for service rendered by the latter’s to the business sector.

Thus payments go around in circular manner as shown by upper portion of the figure. There are also flows goods and services in the opposition direction to the money payments flows. These two flows give GNP = GNI. (Gross National Product = Gross National Income).


So friends, this was the concept of Circular Flow of Income. Hope you get the full details about it and hope you like this article.

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