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In subtopic 1.1.4, we introduced the circular flow of income.
Circular flow of income
An income flow in an economy where the value of the output produced is equivalent the total income earned from its production, which is also equivalent to the expenditures spent on purchasing that output.
The circular flow of income, illustrates how an economy consists of firms and households, which are connected together as a cycle:
National output
The total value of the final goods and services produced by an economy, often measured by real GDP. It is also known as aggregate output.
National income
The total income of an economy, composed of the sum of wages, interest, rent and profit.
In other words, the circular flow of income indicates that:
National output = National income = National expenditure.
We saw that this flow of income can be represented by the circular flow of income model, provided in Figure 1.
Circular flow of income model
A model illustrating the flow of resources from households to firms, the movement of goods and services from firms to households, and the associated monetary flows, including household income generated from selling resources and firms' revenues from selling their products.
The circular flow of income model, illustrates how an economy consists of firms and households, which are connected through the economy:
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