AKA

S P ANNU
HP
A EET
2587 TIL RAS
HM
2583

NAFISA TIN
AT HOD WALA
AJ R
PANK 603 BHAVNESH 2642
2
MAINDAN
2655

HEEN
S INGH A SH
Y AIKH
Y UNJA 2619
MIR
T 2631

IMRAN SHAIKH
2620
 The circular flow of goods and services is a simplified
illustration of basically two flows: the flow of incomes to
households from businesses, and the flow of resources to
businesses from households. It is a circular process that flows in
both directions.

It depicts how goods & services flow in exchange for money.

Circular flow describes how a market economy works. A market

economy is one in which individuals influence directly what is
produced, marketed, and consumed. Individuals do this by
spending money on what they want. This then directs producers
to produce goods and services that individuals will consume.
Circular flow of income represents the total income of a nation.

In Neo Classical economics, the term circular flow of income or

circular flow refers to a simple economic model which describes
the reciprocal circulation of income between producers &
consumers.

A model that indicates how money moves throughout an

economy, between businesses & individuals.
  The simplest circular flow model contains two sectors
(household and business) and two markets (product and
resource). It highlights the core circular flow of production,
income, and consumption.
 A two sector economy consists of households &
firms. It is thus free from government & the external.
Households own factor services & firms use these services.
Household sector receive factor rewards.
In the simple two sector circular flow of income
model the state of equilibrium is defined as a situation in
which there is no tendency for the levels of income (Y),
expenditure (E) and output (O) to change,
that is:
Y = E = O
                   
The basic circular flow of income model consists of six
assumptions:

1.   The economy consists of two sectors: households and

firms.
2.   Households spend all of their income (Y) on goods and
services or consumption (C). There is no saving (S).
3.   All output (O) produced by firms is purchased by
households through their expenditure (E).
4.   There is no financial sector.
5.   There is no government sector.
6.   There is no overseas sector.
7.   It is a closed economy with no exports or imports.
 Another version of the model includes the
government sector. This model highlights the
importance of taxes, which are also diverted from
household sector income and used to finance
government purchases. 
In the three sector model of circular flow of income,
we now introduce the third important institution,
namely the government. Leakages & injections into
the circular flow of income is also caused by the
financial operations of the government.
 The income received by the households sector for their factor
services is spent on the goods & services produced by the firms
& it constitute the consumption  expenditure. The savings &
financial investments are made by the households sector is
matched by borrowings & real investments.
        
 Government income in the form of taxes is matched by
government expenditure on goods & services, subsides &
transfer payments. When the government has a surplus budget
i.e. when it spends less than what it has, the surplus money or
public savings goes to the financial markets. Similarly, when the
government runs a deficit budget, i.e. when it spends more than
what it has, it borrows from the financial market.
 An open economy with the international trade is a open economy.
When we open our economy, the fourth sector, namely, the foreign or
the external sector is obviously added & the model becomes complete.
When a country exports, it receives monetary flows from abroad &
such flows will be considered as injections into the economy.           
 Similarly, when a country imports, monetary flows eject out of the
economy & such flows will be known as leakages, ejections or out
flows. Therefore, exports increase the level of equilibrium income &
imports decrease it. Obviously, if the circular flow of income is to be
in equilibrium, exports & imports must be equal. 
  A circular flow model of the macro economy containing four sectors
(business, household, government, and foreign) and three markets
(product, factor, and financial) that illustrates the continuous
movement of the payments for goods and services between producers
and consumers, with particular emphasis on exports and imports.
The three macroeconomic markets in this version of the circular
flow are:
 
 Product markets: This is the combination of all markets in the
economy that exchange final goods and services. It is the mechanism
that exchanges gross domestic product. The full name is aggregate
product markets, which is also shortened to the aggregate market.
 
 Resource markets: This is the combination of all markets that
exchange the services of the economy's resources, or factors of
production--including, labor, capital, land, and entrepreneurship.
Another name for this is factor markets.

 Financial Markets: The commodity exchanged through financial

markets is legal claims. Legal claims represent ownership of physical
assets (capital and other goods).
 1.  Shows smooth functioning of the economy.

2.  Helps to know the problem of disequilibrium.

3.  Helps to find out leakage(problems) in the circular flow.

4.  Highlights the importance of monetary & fiscal policy.

 The circular flow model presented here is an accepted way to show
the flow of goods and services in a market economy. In a mixed
economy, the government plays an important role as well, but this is
not shown in the circular flow model. Local, state, and federal
governments also produce, or cause the production of, goods and
services.
 Schools, highways, water-treatment plants, parks, and other facilities
are examples of government spending. Governments take part of
household incomes in the form of taxes, but they also inject money
back into households in the form of wages. Some of that money goes
back to the government in the form of taxes and still more goes into
other places.
 The government has considerable control over the economy, which in
turn affects production, employment, and economic growth. If
interest rates go up, households will purchase fewer goods and
services. If interest rates go down, households will spend more. This
spending adds to or takes away from businesses' operations and the
amount of goods and services being produced.
INTRODUCTION:
National income is a very important concept in
economics. It measures the economic performance of the
economy as a whole. All the allied problems of poverty,
inequality, unemployment, performance of the economic
plan, place of growth and economic development, etc. are
studied and evaluated with the help of national income
analysis.
DEFINITION :
According to Pigou, "National Income is that part
of the objective income of the community, including of
course income derived from abroad which can be measured
in money."
 GROSS DOMESTIC PRODUCT
{GDP}
 GDP refers to the aggregate money value of
the output of all types of final goods such as
agricultural goods, industrial goods etc., & all types of
services produced within the domestic territory of a
country during a given year.

 Gross domestic product (GDP) is defined as

"the value of all final goods and services produced in a
country in 1 year".
It can be stated as follows:

In a closed economy, GDP = C + I + G

In a open economy, GDP = C + I + G + (X - M)

Where,
C = Consumer goods & services OR Consumption
goods.
I = Capital goods OR Gross investments.
G = Government services.
X = Exports.
M= Imports.
The GNP is the most widely used measure of national income.
It is the basic accounting measure of the total output of goods
& services.
 Gross National Product (GNP) is defined as "the
total market value of all final goods and services produced in
one year by labour and property supplied by the residents of a
country."
 The term “final” is used to avoid the possibility of
double counting & to ensure that only the value of final goods
& services is considered in measuring GNP. The term “gross”
refers to the fact that depreciation or capital consumption of
goods has not been subtracted from the value of output.
It can be stated as follows:

GNP = C + I + G + (X - M) + (R - P)

Where,
C = Consumer goods & services OR Consumption
goods.
I = Capital goods OR Gross investments.
G = Government services.
X = Exports.
M= Imports.
R= Receipts.
P= Payments.
 NNP refers to net values of all types of goods &
services produced in a country in a given year. To get the
net national product, we must deducted the capital
consumption (D) from GNP.
It can be stated as:
NNP = GNP – Depreciation.
Depreciation is that part of total productive
assets which is used to replace the capital worn out in the
process of creating national output. The NNP gives the
measure of net output available for consumption of the
society. NNP is the better concept than GNP because it
makes proper allowances for the depreciation suffered by
machinery, equipments, buildings, etc. for the year.
 Personal income is the sum of all incomes
received by all individuals or households during a
given year. It is the income actually received by
individuals & households.

It can be stated as:

PI = NI – (social security contributions +
corporate income taxes + undistributed profits) +
transfer payments.
 After accounting for direct personal taxes such
as income tax, wealth tax etc., the remainder of
personal income is known as disposable income.

It can be stated as follows:

DI= Personal Income - Personal taxes.

Disposable income can either be saved or

consumed in different proportions according to the
spending & saving habits of the people.
DI= Consumption(C) + Savings(S).
 The per capita income refers to the average
income per head in the country. It is obtained by
dividing the national income by the total population
of the country.

It can be stated as:

PCI= National Income divided by Population.

The per capita income is considered as an

acceptable index of economic welfare.
 National income of a country can be viewed from different
angles viz. total output, total income or total expenditure. Accordingly
three different methods for the consumption of National Income are used
They are as follows:

1. PRODUCT METHOD OR INVENTORY METHOD

To calculate National Income by this method , We must
calculate the Gross National Product and then arrive at net national
product. While calculating the GNP, It is necessary to avoid double-
counting by taking only the money value of final goods at market prices.
The GNP at market price includes the money value of all types of
consumer goods and services.
The value of all types of capital goods produced in the country
and all types of government services. A net difference between the value
of exports and imports of the country and net foreign income during the
year must be added. To arrive at NNP, we deduct the depreciation of
capital equipment during the year.
2) INCOME METHOD
National Income can also be viewed as a sum total
of the income received by all factors of production during a
specific period, one year. Individuals earn income through a
number of sources such as wages and salaries, rent and royalty,
interest and dividends, profits and professional incomes.
National income is conceived as the sum total earnings of the
factors of production in the form of factor reward viz, rent,
wages, interest and profit. This method is also called National
Income at factor cost. For calculating National Income, following
precautions must be taken: 
 The rental value of owner occupied houses should be added.
 The undistributed profits of the joint stock companies must be
added.
 – Transfer payments in the form of old- age pension,
unemployment doles must be excluded.
– The value of net foreign income should be added.
– The profits of government enterprises must be added.

3)EXPENDITURE METHOD
This method measures the National Income with reference
to the aggregate expenditure of the community on consumption and
investment goods during the year.
It would consist of the following:
– Expenditure on consumer goods and services.
– Expenditure on capital goods i.e. on net addition to capital
goods.
– The net difference between exports and imports. 
Lack of reliable and adequate data:
One of the most important difficulties in estimating
National Income is absence of reliable and adequate data. Without
adequate and reliable data, it is not possible to estimate the volume of
National Income.

Absence of reliable classification of occupation:

There is, generally, absence or lack of clear cut
classification of occupations in many countries. Thus it is difficult to
determine income of individuals who may be engaged in more than
one occupations. As a result of this, it becomes difficult to calculate
National Income.
Difficulty in calculating depreciation:
While calculating National Income, depreciation or wear
and tear of capital goods has to be deducted. But it is not possible to
calculate depreciation accurately. Moreover, the rate of depreciation
may vary from capital asset to capital asset.

 Difficulty in valuation of inventory:

It is also difficult to make valuation of inventory as it
consists of finished and semi-finished goods including raw materials
at the end of the given period of time. of their origin.
Changes in the value of money:
National Income is calculated in terms of money.
But, the value of money is not stable as it changes from time to
time, due to which the estimates of National income are affected
and consequently, it is not possible to have an accurate picture of
the National Income.

Possibility of double counting:

There is a possibility that value of raw materials and
value of final product may be included resulting into over-
estimation of National income. Inclusion of second hand
transactions also leads to miscalculation.
Difficulty arising because of barter transactions:
In rural India, transactions are made on barter
basis and thus, it is possible to get the proper estimates of
National Income.

 Problems regarding inclusion of Income of multi- national

concerns:
The problem is whether their income should be
included in the National Income of the country where they
operate or in the National Income of the country
Difficulty in computing money generated: Income derived
from illegal activities such as smuggling is not reflected in
total National Income and to that extent, there is a shortfall in
the volume of National Income.

 Difficulty due to International Trade:

There are also difficulties in calculating the
volume of National Income due to international trade. It is
necessary to deduct the value of goods and services imported
and to add value of goods and services exported. But, in
absence of exact data about national export and import,
National Income is likely to be miscalculated.
The fiscal year 2009-10 began with difficulty because there was a
significant slowdown in the growth rate of the Indian economy in the
second half of 2008-09. The growth rate of the GDP in 2008-09 was
6.7 per cent, with growth in the last two quarters being around 6 per
cent. There was fear that this trend would continue for sometime, as
full impact of the global recession is felt in the due course of time.
The government had taken a calculated risk in providing substantial
fiscal expansion to counter the negative impact on the global
recession.
As a result, India’s fiscal deficit increased to 6.8 per cent
(budget estimate) of GDP in 2009-10 from 5.9 percent in the
previous year. The monsoons failed and contributed to
unprecedented rise in food prices during the year. The continued
recession in the developed world, for better part of 2009-10, meant a
poor export recovery and a slowdown in financial flows into the
economy. However, the Indian economy achieved a remarkable
recovery which justifies optimism for the medium to long term.
 The economy turned around in the second quarter of 2009-
10 when it grew by 7.9 per cent . As per advance estimates of
GDP for 2009-10, released by the CSO, the economy was
expected to grow at 7.2 per cent in 2009-10. However, the
industrial sector posted a growth rate of 16.3% in the last quarter
thereby averaging a 10.8% growth in the fiscal year 2009-10 and
the agricultural sector sprung a surprise by posting a positive 0.2
percent growth against a projection of negative 0.2 per cent and
the mining sector grew to be 7.4 per cent. This recovery is good
for three reasons.
First, it has taken place with a plus 0.2 per cent in
agricultural output. Second, it signals renewed momentum in the
manufacturing sector, which had seen continuous decline in the
growth rate for almost eight quarters since 2008-09 to 10.8 per
cent in 2009-10. Third, there has been a spectacular recovery in
the growth rate of gross fixed capital formation with 34.6%
growth in the last quarter, which had declined significantly in
2008-09 as per revised National Accounts Statistics (NAS).
 The quick recovery of the economy explains the effectiveness
of the policy response of the Government in the wake of the global
financial crisis. Moreover, the broad based nature of the recovery
creates scope for a gradual rollback, the fiscal stimulus given by the
government. A major concern during the year 2009-10 was the
emergence of high double- digit food inflation. On a year basis, WPI
Inflation in December 2009 was 7.3 per cent but for food items
(primary and manufactured) with a combined weight of 25.4 per cent
in the WPI basket, it was 19.8 per cent.
The upsurge in prices in the second half of 2009-10 has been
confined to food items only. As of the week ending January 30, 2010
the inflation in primary food articles stood at 17.9 per cent, and the
fuel, power light and lubricants at 10.4 per cent. A significant part of
inflation was caused by supply- side bottlenecks in some of the
essential commodities. Since December 2009, there have been signs of
these high food prices, together with the gradual hardening of non
administered fuel product prices, getting transmitted to other non- food
items, thus creating some concerns about higher than anticipated
generalized inflation over the next few months.
(1) The Indian economy recovered in the year 2009-10.
What figures will help you to prove the recession in Indian
economy?
Ans: The growth rate in 2008-09 was only 6.7%. In the previous
years, the growth rate of the Indian economy was 9.7% in
2006-07 and 9% in 2007-08. A sustained fall in growth rate
therefore indicates that the Indian economy was in the recession
from 2006-07.

(2) The food items both primary and manufactured have a

combined weight of 25% in the WPI consumption basket.
With food prices going up by about 20% and assuming
constant money incomes of the unorganized workforce in
India, what will be the extent on their real incomes?
Ans: If food prices by 20% in a year and if the weight of food items
is 25% in the consumption basket, with the constant money
incomes, the real income of the unorganized workforce in India
should fall by 5% ( 20% of 25% is 5%), thereby reducing their
economic welfare.
(3) What proves the fact that the recovery of the Indian economy in
2009-10 has been good?
Ans: The economy turned around the second quarter of 2009-10 when it
grew by 7.9 per cent. As per the advance estimates of GDP for 2009-10,
released by the CSO, the economy was expected to grow at 7.2 per cent in
2009-10. However, the industrial sector posted a growth rate of 16.3% in
the last quarter thereby averaging a 10.8% growth in the fiscal year 2009-
10 and the agricultural sector sprung a surprise by posting a positive 0.2
per cent against a projection of negative 0.2 per cent and the mining
sector grew at 10.6 per cent. The actual growth for the fiscal year 2009-10
turned out to be 7.4 per cent. This recovery is good for three reasons.
First, it has taken place with a plus 0.2 per cent growth in
agricultural output. Second, it signals renewed momentum in the
manufacturing sector , which had seen continuous decline in the growth
rate for almost eight quarters since 2007-08. Manufacturing growth had
more than trebled from 3.2 per cent in 2008-09 to 10.8 per cent in 2009-
10. Third, there has been a spectacular recovery in the growth rate of
gross fixed capital formation with 34.6% growth in the last quarter, which
had decline significantly in 2008-09 as per revised National Accounts
Statistics ( NAS).