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Explain the circular flow of income in a simple economy.

Asked by Topperlearning User 15th April 2016, 2:30 PM
Answered by Expert

In a simple economy, there are firms and household sector’s economic activity. People from households render factor services to firms and firms hire factor services from households. Households spend their earned income completely on consumption. Products which are produced by firms are sold to consumers; assuming that there is no external trade and no government in the economy. 


i. Total production of goods and services by firms are equal to the consumption of goods and services by firms.  

ii. Factor payments by firms are equal to the factor incomes of the household sector.

iii. Consumption expenditure of household sector is equal to income of the household sector.

iv. Money flows are opposite to real flows because factor services flows from households to firms are real flows and the factor payments made by firms to households are money flows.

Answered by Expert 15th April 2016, 4:30 PM
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