Discuss about the circular flow of income

Subject Economics
NU Year Set: 2.(b) Marks: 4 Year: 2012

The circular flow of income is a neoclassical economic model depicting how money flows through the economy. In its simplest version, the economy is modeled as consisting only of households and firms. Money flows to workers in the form of wages, and money flows back to firms in exchange for products. This simplistic model suggests the old economic adage that supply creates its own demand.

Income (Y) in an economy flows from one part to another whenever a transaction takes place. New spending (C) generates new income (Y), which generates further new spending (C), and further new income (Y), and so on. Spending and income continue to circulate around the macro economy in what is referred to as the circular flow of income.

The circular flow of income forms the basis for all models of the macro-economy, and understanding the circular flow process is key to explaining how national income, output and expenditure is created over time.

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