CHAPTER

, . cULAR
.,. . -~·"
vl
OF IN .I
'

LEARNING OBJECTIVES
1.1 Meaning of Macroeconomics 1.4 Types of Circular Flow
1.2 Circular Flow of Income 1.5 Circular Flow in a Simple Economy
1.3 Stock and Flow (Two-sector Economy)

1.1 MEANING OF MACROECONOMICS

---------- --------
The term 'macro' has been derived from the Greek word 'makros' which means 'large'. So,
macroeconomics deals with overall performance of the economy. It is concerned with study of
problems of the economy like inflation, unemployme nt, poverty, etc.
Macroeconomics is that part of economic theory which studies the behaviour of aggregates of the
economy as a whole. For exam ple, National income, aggregate output, aggregate consumption ,
etc. Its main tools are Aggregate Demand and Aggregate Supply.

Difference between Microeconomics and Macroeconomics

You have already studied Microeconom ics in your previous class. Let us now study the various
points of difference between Microeconom ics and Macroeconomics.

Basis Microeconomics Macroeconomics

Meaning Microeconomics is that part of economic Macroeconomics is that part of economic
theory which studies the behaviour of theory which studies the behaviour of
individual units of an economy. aggregates of the economy as a whole.
Tools Demand and Supply. Aggregate Demand & Aggregate Supply.

Basic Objective It aims to determine price of a commodity It aims to determine income and
or factors of production. employment level of the economy.

Degree of Aggregation It involves limited degree of aggregation. It involves the highest degree of
For example, market demand is derived aggregation. For example, aggregate
by aggregating individual demands of all demand is derived for the entire economy.
buyers in the particular market.
Basic Assumptions It assumes all the macro variables to be It assumes that all the micro variables, like
constant, i.e., it assumes that national income, decisions of households and firms, prices
consumption, savings, etc. are constant. of individual products, etc. are constant.

1.1
 • Other Name
Microeconomics Is also known
Introductory Macroeconomics

Macroeconomlcs Is also kno

as 'Price , wn as 'lncorne
Theory' as It Is primarily concer
ned with d Employment Theory as 1t..1s
an primarily
determination of prices of com
modities concerned with determ.ination
. ofl
evel of
and factors of production. income and employment.
Examples
Individual income, individual out National Income, National out
put. put.
Need for a Separate Theory
of Macroeconomics
Microeconomics failed to study
the aggregates of the economy as
a need for a separate theory, wh a whole. As a result, there Was
ich could explain the working
helps to understand the working of of the econo~y. Macroeconomics
an economic system as well as to exp
paradoxes. lain the vari~us macroeconomic

1.2 CIRCULAR FLOW OF IN

COME _ _ _ _ _ _
____ _ __
Introduction
The unlimited and recurring
wants of human beings have
continuous process. In this pro made the production process,
cess, different factors of produ a
Enterprise are combined togeth ction : La nd , Labour, Capital and
er for production of goods and
• Firms produce goods and ser servic es.
vices with collective efforts of fac
by the household sector. tors of production supplied
• Firm makes payment to the
factors of production in the for
profit (known as factor incom m of rent, wages, interest and
es).
• The household sector spends
this money on the purchase of
by the firms. goods and services produced

I
Thus, income flows first from
firms to households in the form
households to firms in the form of factor payments and then,
of consumption expenditure. from
circular flow of income. Such a flow of money is known as
the
Meaning of Circular Flow of
Income
It refers to cycle of generation
of income in the production pro
the ftldors of production an cess, its distribution among
d finally, its
circulation from households to
Jinns in the Production Phase
fonn ofconsunq,tion expenditure
on goods (Generation ofIncome)
and savias produced by them.
Phases of Circular Row of Inco
me
There are 3 different phases
(generation, Income Phase
dis tri bu tio n an d disposition
) in circular (Distribution of Income)
flow of income, as shown in
the given
diagram:
t. Ge ne ra tio n Ph as e: In this
firms produce goods an d servic
the help of factor services.
ph as e,
es with
~-J
(Olsposltion ofIncome)

Fig. 1.1
Chapter 1 ■ Circul11r Flow of Income

2. Distribution Phase: This phase involves the flow of factor income (rent, wages, interest
and profit) from firms to the households.
3, Disposition Ph,'lsl': In this phase, the iJ,come received by factors of production, is spent
on the goods and services produced by firms.
ln thi..-. way, income generated in production units reaches back to production units and makes the
circular flow complete.

1.3 STOCK AND FLOW _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __

The concepts of stock and flow are used frequently in macroeconomics. Some of the macro
variables relate to stock, while others relate to flow. Therefore, it is important to understand
their meaning so that variables can be categorised as stock or flow.
Stock
Stock variable refers to that variable, which is measured at a particular point of time.
for example, stock of goods in the godown as on 31st January, 2023. It means, stock variables
are not time dimensional. Some more examples of stock variables are national wealth, national
capitaL money supply etc.

Flow
r-+- Stock of water
Flow -oariable refers to that variable, which is measured in a tank
01Jer a period of time. For example, production of goods ----------
during the month of January 2023, birth rate in the year 2022,
national Income in the year 2022 are flow variables. The
'period of time' could be a day, a week, a year, etc. It means,
Flow of water
flow variables are time dimensional as they are measured ..... ~
•': from tank
for a period of time.
Examples for Better Clarity
• The amount of water in tank is the quantity of water in the tank at a given point of time.
On the other hand, water flowing into the tank from a tap is a flow of water being added
to the tank per unit of time.
• The total number of houses as on 31st December, 2022 is the stock concept, while the number
of houses constructed during the year 2022 is a flow variable.

Difference between Stock and Flow

Flow variable refers to that variable, which

aparticular point dtlme. is measured over a period of time.
eu1P.tcl08wothlve a time dimension. It has a time dimension as its magnitude
can be measured over a period of time.
It Is a dynamic concept
 Introductory Macroec
0 norr.•
·•1lcs

Examples 1. Population of India as on 31 .03.22. 1. Number of births during 202 .

2
2. Total number of Maruti cars in Delhi. 2. Maruti cars manufactured du .
3. Money supply {money in circulation). January, 2023. r1n
9
4. National Wealth. 3. Expe nditu re or transactions in lllo
5. Quantity of wheat stored. 4. National Income. ney,
s. Quantity of wheat produced.
1.4 TYPES OF CIRCULAR FLOW _ _ _
_ _ _ _ __ _ _
There are two types of circular flows: (i) Real flow
; (ii) Money Flow.
Real Flow
Real flow refers to the flow of factor services from hous
eholds to firms and the corresponding
flow of goods and services from firms to households.
As seen in the diagram, households provide factor
services to the firms which, in tum, provid
goods and services to them as a reward for their prod . . e
uctive services.
• It is also known as 'Physical flow'.
• There is only exchange of goods and services betw
een the two sectors without involvement
of any money.
• Real flow determines the magnitude of Factor Services
(Land, Labour, Capitol & Enterprise)
growth process in an economy. For example,
when more factor services are offered to HOUS
EHOLDS
firms, then volume of production will be more
and it speeds up the process of economic
growth. LGoods ind St rvlcts

Money Flow Fig. 1.2

Money Flow refers to flow offactor paymn,ts from firm
s to households for their fa ctor services
and corresponding flow of consumption aptn dihl rt
from households to firms for purchase of
goods and seroices produced by tht Jinns.
As seen in the diagram, firms make factor

_
Consumption Expe nditure
payments to households for their factor services On Goods and Services)
and households spend this income on purchase __.._ _____
of goods and services produced by the firms. HOUS EHOLDS
'-----r---'
• It is also known as 'Nominal flow'.
• It involves exchange of money between the
two sectors.
L
facto, P1yments - -
(Rfflt. Wages, Interest & Profit)

.,. ... _. .., _... RMI Flow llll d.. _., Flow Fig. 1.3
S,ht~ Rea: Flow Money Flow
M• bl
I Gr r •-•hoe
• • • . . of goods ad senlces ltistheflow
!I alb households.
cf money between firms and

_ . _ wha age of goods and It irMJlves exch

ange of money.
chapter 1 ■ Circular Flow of Income

-Difficulty in exchange There may be difficulties of barter system There is no such difficulty In case of money
in exchange of goods and factor services. flow.
~ ---------i------=---
Alternative Name It is also known as Physical Flow. It is also known as Nominal Flow.

four Sectors of the Economy

The four major sectors in an economy according to the macroeconomic point of view are:
1. Household Sector: It includes consumers of goods and services and also the owners of
factors of production. They supply factors like land, labour, capital and entrepreneur and
receive income in return in the form of rent, wages, interest and profit respectively.
2. Producing Sector (Firms): It includes all producing firms in the economy. To produce
goods and services, the firm hires factors of production from the households.
Households consume goods and services to satisfy their wants and firms produce goods and services
to make a profit.

3. Government Sector: It acts in two capacities:

• As a welfare agency, it is involved in maintaining law and order, defence and other
services of public welfare.
• As a producer, it produces goods and services in public sector enterprises.
4. Foreign Sector (or External Sector or Rest of the World Sector): This sector includes
transactions with the rest of the world. It is involved in export and import of goods and
flow of capital between the domestic economy and other countries of the world.

1.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) _ _

A simple economy assumes the existence of only two sectors, i.e. household sector & firm sector.
• Households are the owners of factors of production and consumers of goods and services.
• Firms produce goods and services and sell them to the households.
It is the simplest form of closed economy**, in which there is no government sector and foreign
trade.

I ··iH,M,:fii,i·l-)·M,1iH:M,,N
Closed Economy is an economy which has no economic relations with rest of the world. However,
In the current scenario, there is hardly any country which does not have any economic relations with
other nations. Adosed economy has 3 sectors: Household Sector, Producing Sector and Government
Sector, i.e. It does not have any Foreign Sector.
o,.1c:a_,...15., economy which has economic relations with rest of the world. In the current
~ ~ ~shave economic relations with other nations. An open economy has 4 sectors:
~ f'todudng Sector, Government Sector and Foreign Sector.

In order to make our analysis simple, we take some assumptions:

1. 'There are only 2 sectors in the economy: Households and Firms. It means, there is no
igovemment and foreign sector.
 Introdu ctory Macro
-.,
~Cbnol't\1~,
2. Housl'hold Sl'ChW ~"l'Plil'~ foct-or , I t firm ~ and tlw firm s hir e fact
St'f Vlf l'~ on y o ,
on\v from hou:--l'holds . or !k~ryi<:.~
· h h
v1t t'S an d ~~c,11 their entire output tot e ow,ehold s
3 Hrms prodm~t:' ),1;,,ods and ser . ,
.. ·
4. lfou~eholds n'Ct'tvr factor . · s ,rvicc s and spend the enti re• . .
mcom e for th cir ·c · arn
consum.ption of goods and servic · ritJnt ~
es. . , .
. .
S. Th~,-e arc no savmg s m t1,c econo my, i·e· neither the hou sehold s sav e from the1.r in
nor the firms save from their pro crJJ'r\~
fits. factor S~rvices
The Circular flow in Two-Sector eco ·'
nomy bour, Capital and
o"d, \.O • n E 6
can he better understood with the ~ '1'9t,o xp~r,d/ ,,,e'I)~.,.e
.
help of c.,o~""' c,oods and Se,11
Fig . 1.4. .· t«,,.ta v
\01" lees;
• The outer loop of diagram sho
ws
the real flow, i.e. flow of fac
tor
services from households to firm
s HOUSEHOLDS
and corresponding flow of goods
and
services from firms to households.
• The inner loop shows the money
flow,
i.e. flow of factor payments from firm tor Pay
s
to households and the correspondin ges, Inter
g
flow of consumption expenditu dsa ndS
re
from households to firms.
Fig . 1.4

I It must be noted that entire amoun

by the factor owners to the firm

In the circular flow of income,

t of money, which is paid by firm
s. So, there is a circular and continu
s as factor payments i~ paid back
ous flow of money income.
production generates factor income, which is converted
expenditure. This flow of income into
continues as production is a contin
ending human wants. It makes the uous activity due to never-
flow of income circular.
Conclusions of Circular Flow in
a Simple Economy
In a Two-Sector Economy, the
following Conclusions can be dra
(i) Total Production of goods
wn:
and services by Firms= Total Co
services by Households. nsumption of goods and
(ii) Factor Payments by firms =
Factor Incomes of households.
(iii) Consumption Expenditure
by households = Factor Income of
(iv) Real Plow in the form households.
of factor services and final good
between firms and households. s and services= Money Flow
chapter 1 ■ Circular Flow of Income

II REVISION OF KEV POINTS

• Macroeconomics is that part of economic theory which ~tudles the behaviour

of aqqregates of the economy
as a whole. For example, National income, aggregate output.
• Circular Flow of Income refers to the cycle of generation of income In the product
ion process, its distribution
among the factors of production and finally, its circulation from households to the
production units in thP.
fonn of consumption expenditure on goods and services produced by these
units.
• Three Phases of Circular Flow of Income
(i) Generation Phase; (ii) Distribution Phase;
(iii) Disposition Phase.
• Flow Variable refers to that variable, which Is measured over a period of time.
• Stock Variable refers to that variable, which is measured at a particular point
of time.
• Real Flow refers to flow of factor services from households to firms and the
corresponding flow of goods
and services from firms to households.
• Money Flow refers to flow of factor payments from firms to households
for their factor services and
corresponding flow of consumption expenditure from households to firms for
purchase of goods and
services produced by the firms.

SYNONYMS OR S!MllAR TERMS OF THIS CHAPTER

.. .
RealAow Physical Flow
MoneyAow Nominal Flow

I[ GUID ELINE S TO NCERT QUESTIONS

1. What is the difference between microeconomics and macroeconomics?

Hint Refer'Difference between Microeconomics and Macroeconomics'.
2. Describe the four major sectors in an economy according to the macroe
conomic point of view.
Hint: Refer 'Four Sectors of the Economy'.
3. What are the four factors of production and what are the remunerations to each
of these called?
HintThe four factors of production are: (i) Land, (ii) Labour, (iii) Capital, and (iv) Entrepre
neur.Their remuneration
takes the form of (i) Rent, (ii) Wages, (iii) Interest, and (iv) Profit.
4. Distinguish between stock and flow. Between net investment and capital
which is a stock and which is a
flow? Compare net investment and capital with flow of water into a tank.
Hint:Oiscuss•Difference between Stock and Flow•. Between net investment and
capital, capital is a stock and
net Investment is a flow.

II HOTS: HIGH ER ORDER THIN KING SKILLS QUESTIONS

Q. 1. "In atwo-sector economy, national product is equal to national income: Comme

nt.
..._ tn a two-sector model, the national product, In terms of money value of goods
and services produced,
1s dlS1rlbuted among the productive factors. It means, total money value of output is given to factors of
;podudlon In the form of rent, wages, Interest and profit for their factor services. So, nationa
l product (value
dthe goods and services produced) is exactly equal to national income (income generated).
 Introductory Macr o - ,
econQI\..,
·•11c\
Q. 2. "Flow of Income is circular in t economy" Comment
. a two -sec or · • a two sector economy.The
.
Ans. The given statement 1s correc t, i flow of income is circu 1ar ,n inc
.e. t by them on purchase of goodsomere
by households from firm s fo~ thei Ceiv
r factor services Is s~:~e it had com
produced by the firms. Thus, income
goes back from w
e. This flow of income :nd~ervi
0nt1n1 ~d
production is a continuous process. Jes s
Q. 3. How does real flow consist ai
of factor flow and product flow?
Ans. Real flow consists of two kind
s of flows:
(i) Factor flow: It Is the flow of fi
factor services from households to
rms .
(ii) Product Flow: It is the flow of · from firms to households.
goods an d services
Q. 4. Classify the following as Sto
ck and Flow:
(i) Amount of bank deposits as on
31.03.2022
(ii) Losses
{CBS E, Delh i Comptt
(iii) Production of wheat during the .20, ,
year 2020-21 {CBSE, 2022 (58/4/2) 7i 1
(iv) Profit errn.2)
{CBSE, All India Comptt
(v) Population of India as on 3,st · 201
March, 2021 (CBS E, 2022 (58/4/1 ) 7i 1)
(vi) Number of literate people as erm•2 )
on 31.03.2022
(vii) Savings
{CBSE, All India Comptt. 2017 , Delh
(viii) National Income of Indian Eco i
nomy during the financial year 202 20131
(ix) Capital 0-2 1. ~CBS E, 2022 (58/4 /2) Term.
{CBSE, All lnd,a Comptt. 2017, Delh 21
(x) Number of persons employed i 2013
during December 1
(xi) Balance in a bank account
(xii) Raw material in a godown as {CBSE, All India Comptt.
on 31 st January, 2023 201 11
(xiii) Production
(xiv) Wealth {CBSE, Delh i Comptt. 20l lJ
{CBSE, Delhi Comptt. 2011, Delh i 20
(xv) Gross domestic product 131
(xvi) Domestic Income of Indian {CBSE, Delh i2013)
Economy during the fiscal year 202
(xvii) Value of Inventories as on st 0-21 {CBSE, 2022 (5814/ 1) Term-2)
31 March, 2021
(xviii) Net Investments during the {CBSE, 2022 (58/ 413) Term-2)
year 2020-21
Ans. (i) Stock as they are related (CBS E, 2022 (58/4/3) Term-2)
to a point of time.
(ii) Flow as losses are measured
over a period of time.
(iii) Flow as production is measure
d over a period of time.
(iv) Flow as profit is measured ove
r a period of time.
(v) Stock as population is related
to a point of time.
(vi) Stock as it is related to a poin
t of time.
(vii) Flow as savings are related to
a period of time.
(viii) Row as national income is rela
ted to a period of time.
(ix) Stock as capital is related to a
point of time.
(x) Flow as It is related to a period
of time.
{xi) Stock as It Is related to a poin
t of time.
(xi Stock as It Is related to a point
of time.
(xiii) Flow as production Is measure
d over a period of time.
(xiv) Stock as wealth Is related to
a point of time.
(xv) Flow as gross domestic produc
t Is measured over a period of time
(xvi) Flow as domestic Income of .
Indian Economy Is related to a period
{xvii) Stock as It ls related to a poi of time.
nt of time.
(xviii) Row as net investments Is rela
ted to a period of time.
Chapter 1 • Circular Flow of Income

Q. s. Explain the circular flow of Income. (CBS[, Deihl 2oI3, Delhi Comptt.20 15}
Ans. The Circular flow of Income can be better understood with the help of following diagram:
f 8 ct.or Services
our, Capirat
ptlon hp
oodsand

HOUSEHOLDS
FIRMS

torPaym
ges, lnteres
Goods and Se

Incomes are first generated in production units due to the joint efforts of factor owners from households.
These incomes are distributed to the factor owners who in turn spend the income on purchasing goods
and services produced in production units. This makes the circular flow of income complete.
Q. 6. 'Circular flow of income in a two sector economy is based on the axiom that one's expenditure is other's
income~ Do you agree with the given statement? Support your answer with valid reasons.
{CBSE, Sample Paper 2020, 2020 (58/2/1))
Ans. Yes, the given statement is correct. In atwo sector economy, the firms produce goods and services and make
factors payments to the households. The factor income earned by the households will be used to buy the
goods and services which would be equal to income of firms. The aggregate consumption expenditure by
the households in the economy is equal to the aggregate expenditure on goods and services produced by
the firms in the economy (Income of the producers).

II _- OBJECTIVE QUESTIONS

Fill in the Blanks

1. In the _____ phase, income received by factors of production, is spent on goods and services
produced by _ _ __
2. In a two-sector economy, there is no _____ and _____ sector.
J. _____ variable refers to that variable, which is measured at a particular point of time.
4.
----- flow determines the magnitude of growth process in an economy.
5. _____ variables are time dimensional.
6. Real Flow is also known as _ _ _ __
7. In a two-sector economy, Household sector supplies factor services only to _ _ _ __ and the firms
hire factor servtces only from _ _ __
I. Real Flow Involves exchange of _____ a n d - - - -
1. _ _ _ _ is also known as Nominal Flow.
 Introductory Macro
ecorio
rtlics
1o. - - - - phase Involves flow of factor Income from firms
to the households.
11. _ _ _ _ variable Is a dynamic
concept.
12. Flow of factor paymentsand payments
for goods and services between hou seholds
_ _ _ _ (Nominal Flow/ Physical Flow and firm siskno'Nn
)
13. , 2,000 note lying in wallet of Rohinl, as
a student is an example of - - - - - t I
(S ock flow) variable
{CBSE, 2020 (S;
1~ (Microeconomics/Macroeconomics) deals
---- with study of employment level in the econ 1411
)!
orny,
True or False with Reasons
1. Capital formation is a flow.
{CBSE, Sample Pap
2. Real flow is also known as nominal flow er 201oi
.
3. Generation and distribution are the two
phases in circular flow of income.
4. In a two-sector economy, total productio
n is always equal to total consumption .
5. National Income of a country is a stock
concept.
6. Circular flow of income does not take plac
e in case of closed economy.
7. There are no exports in a closed economy
.
8. 'Inventory is a stock variable:
9. The problem of price determination of {CBSE, 2020 (5a;511)}
a product comes under the purview of mac
roeconomics.
Matching Type Questions
Q. 1. From the set of statements given
in Column I and Column II, choose the correct pair of
statements:
Column I ,
I Column II
(a) Money Row (i) It involves exchange of goods and serv
ices
(b) Stock (ii) It has a time dimension
(c) Real Flow (iii) It is also known as Physical Flow
(d) Flow (iv) It is a static concept.

Q. 2. Match the statements given under A with

the correct options given under B.
(A) '.
(8)
(i) Stock a. National Income
b. National Wealth
Q. 3. Match the statements given under A with
the correct options given under B.
(A)
{B)
{I tlomtnal&ow ,a. It Jnvolves exchange of goods and services
b. It Involves exchange of money
Q. 4. Match the statements given under A
with the correct options given under B.

d.servkeseetween firms and households

~ Circular Flow of Income
,
11
,pter 1 •

eyFloW c. Variable measured o~--;-;;rlod time~f

(liil Mon d. Nominal Flow - --------------
(iv) stock
•• tch the statements given under A with the correct options given under B
Q,S, ,v,a . . .

(i) Microec_
on_o_m~ic:-s_ _G:"-;ln~c:o:m~e:-;a:-=
n-=--
d-:--
Em-p
:-lo_ym
_ en_t_T_
he_:o..:..:ry:__ _ _ _ _ _ _ _ _ _ __
••acroeconomics b. Positive Economics
(Ii) IYI
c. Price Theory

Multiple Choice Questions (MCQs)

Which of the following is a phase of circular flow of income?
1
' (a) Generation Phase (b) Distribution Phase (c) Disposition Phase (d) All of these
2- Which of the following is not an example of flow variable?
(a) Number of births during a year (b) National wealth
(c) National Income (d) Wheat produced during a year
• Which of the following is not considered a factor income?
3
(a) Rent (b) Wages (c) Gifts from abroad (d) Profit
4. Two-sector economy consists of:
(a) Households, firms (b) Firms, Foreign sector
(c) Households, Government (d) Firms, Government
s. Stock variable is defined as a variable which is:
(a} Measured over a period of time (b) Measured at a particular point of time
(c) Cannot be measured (d) None of these
6. Losses are classified as:
(a) Stock variable (b) Flow variable (c) Either (a) or (b) (d) Neither (a) nor (b)
7. Real flow is also known as:
(a) Nominal flow (b) Physical flow (c) Money flow (d) Both (a) and (b)
a. Which of the following sector is not included in a two-sector economy?
(a) Government (b) Firms (c) Households (d) All of these
9. Money flow involves exchange of:
(a) Goods and services (b) Gifts (c) Money (d) None of these
10. Real flow refers to the flow of factor services from _ _ __
(a) Firms to households (b) Households to firms
(c) Firms to government (d) Households to government
11. In adosed economy, _ _ _ is not included.
{a) Households (b) Firms (c) Government (d) Foreign sector
12. Which of the following Is not a flow? {CBSE, Delhi Comptt. 20 15}
(a) Capital (b) Income (c) Investment {d) Depreciation
JI, NIida of the following is a stock? {CBSE, All India Comptt.2015}
M-wealth (b) Saving (c} Exports (d) Profits
 1.12 Introductory Macroecon .
ornics
14. Which of the following diagram
repr esents Real Flow?

1 r
Consumption
[

~ eholfil
Expenditure
Goods 11nd
Services 7._ [
Factor
_ Services l_ Factor
Services l
r -Flrms] ["Bo~~ehol~;i J (Fo~~eholf} [FJrms ] [Eo
- u~se-ho-ld-s [F~._
L- ~oodsand J . ..l Factot
( _Firms
J -l Goods and J - ,-
L Factor
- !rms ]
J ...
Services Services Services Payments
(a) (b) (c) (d)
15. What does the following diagram
represent?
(a) Real Flow
(b) Money Flow
I Consumpt ion
Expenditure l
(c) Nominal Flow Households - F:----..
1 irms i
(d) Both (b) and (c) Facto r J
Ir
16. Circular Flow of Income is corr Payments

I 1 ~
ectly represented in the diagram:

I
Ir Jjl 7 - J1j'
Factor Services

l~
Goods and Services
Fact;::t:~ices
I Consumption Consumption
Goods F:: :ervices

~
Expenditure Expenditure Payments

~H....:..ou_.se..__ho-ld--,s Jj l
I I
.---- '---' --~

Ho"seholds
Payments
0

l 1
l LF act or ?irms
J,
factor Consumption
Payments Payments Consumption
Goods and Services Expenditure Expenditure
Factor Services Goods and Services
(a) Factor Services
(b) (c)
17. Which of the following is a flow (d)
?
(a) Deposits in a bank {CBSE, Delhi Comptt. 2016}
(b) Capital (c) Depreciation (d) Wealth
18. Which ofthe following is a stoc
k?
(a) Savings {CBSE, All India Comptt. 2016}
(b) Production
(c) Consumption of fixed capital
(d) Capital
19. Flow of Goods and services and
factors of production across differen
as: t sectors in a barter economy is known
(a) Circular Flow {CBSE, Sample Paper 20 16}
(b) Real Flow (c) Monetary Flow
20. Continuous sectoral flow of goo (d) Capital Flow
ds and money in an economy is kno
(a) Real Flow wn as _ _ _ __
(b) Nominal Flow (c) Circular Flow
21. In a two-sector economy, __ (d) None of these
__ depend on __ __ for sup
(a) Arms, Households
ply of factor services.
(b) Households, Firms
(c) Firms, Government
(d) Government, Households
22. Which of the following is include
d in Real Flow?
(a) Flow of Services (b) Flow of Goods (c) Both (a) and (b) (d) Flow of Money
23. Inventory is a __ __ _ con
cept, whereas the change in inventor
y is a _ _ _ _ concept.
(a) Stock, Flow {CBSE, Sample Paper 2021 }
(b) Flow, Stock
(c) Stock, Stock (d) Flow, Flow
24. Which of the following is conside
red as 'Real Flow' in the Circular Flow
(a) Flow of factor services from hou of Income?
seholds to firms
(b) fJow ofgoods and services from
firms to households
{c) Both (a) and (b)
td) 'Aow of factor payments from firms
to households
 Circular Flow of Income
,,.,pt•r 1
• In a two sector econ~my, firms depend on the households for supply of:
25
{,,\ Goods and Services (h l Factor Inputs (, ) Both (a) and (b) fd J None of these
nominal flow In the circular flow of income?
26, Which of the following is considered as a part of
1,il Flow of goods and services from firms to households
lt•l Flow offactor payment from firms to household
1, , Flow of factor services from households to firms
i,1 i All of these
27, Macroeconomics focuses on all of the following except:
1;11 Unemployment Problem (b) Inflation in the Economy
(c' Aggregate Demand (d) Cotton Textile Industry

28, Read the following figure carefully and choose the correct pair from the alternatives given below:
{CBSE, Sample Paper 2022-23)

Natlonal _ __._._.m'-_
(Generation Phase)

National Income
Distribution Phase

National Expenditure
(_liil__ Phase)

(a) Output, Production (b) Value added, Production

(cl Output, Disposition (d) Wealth, Development

Assertion Reason Questions (ARQs)

. . -, ',!:'!, ~ - - ' " - "'l".:aiiliiliilli "" -- - ·7
11NSTRUCt!ONS .-:••$:'-:

In the following Questions, read the following statements: Assertion (A) and Reason (R). Choose the
correct alternative among those given below:
Alternatives:
(a) Both Assertion (A) and Reason (R) are True and Reason (R) is the correct explanation of Assertion (A).
(b) Both Assertion (A) and Reason (R) are True and Reason (R) is not the correct explanation of Assertion (A).
(c) Assertion (A) is True but Reason (R) is False.
(d) Assertion (A) is False but Reason (R) is True.

1. Assertion (A): Savings are zero in case of two-sector economy.

Reason (R): Households spend the entire factor income received from firms on consumption of goods and
services.
2. -AnMtlon (A): Stock variable does not have a time dimension.
,. . . _ (R): Stock variable is measured over a period of time.
(A):Total production is equal to total consumption in case of circular flow in atwo-sector economy.
(I): Household sector supplies factor services only to firms and the firms hire factor services only
ouseholds.
 Introductory Macroecono
~
rnics
4. Assertion (A): Real Flow is also known as Nominal
Flow.
·
Reason (R): Real Flow involv es flow of goo ds an d serv Ices between firms and household s.
5. Assertion (A): Macroeconomics is also known as
Income and Employment Theory.
Reason (R): Macroeconomics · · d · ·
aims to etermme income and employment level of the economy
•
Statement Based Questions
INSTRUCTIONS
In the following Questions, read the following statement
s and choose the correct alternative among
those given below:
Alternatives:
(a) Both the Statements are true. (b) Both the Statements are false.
(c) Statement 1 is true and Statement 2 is false. (d) Statement 2 is true and Statement 1 is false.

1. Statement 1: Real Flow involves exchange of goods

and services.
Statement 2: Real Flow is also known as Nominal Flow.
2. Statement 1: In a two-sector economy with households
and firms, there are no savings in the economy.
Statement 2: Real Flow in the form of factor services and
final goods and services is equal to money flow
between firms and households in a two-sector econo
my.
3. Statement 1: Circular flow of income does not take
place in case of closed economy.
Statement 2: Flow of income is circular in a two-sector
economy.

I
Author's Note: There is a possibility that the seque
nce of the options are interchanged in the examination
standardize sequence we follow). So, students are advise (i.e. not like the
d to carefully read all the 'Alternatives' before choosing
option. For example, alternatives are different in 4 and the correct
5.
4. Read the following statements carefully and choos
e the correct alternative from the following:
Statement 1: Real flow refers to the flow of factor servic
es from firms to households.
Statement 2: Flow of goods and services and factors
of production across different sectors in a barter
economy is known as capital flow.
Alternatives:
(a) Both the statements are true. (b) Both the statements are false.
(c) Statement 1 is true and Statement 2 is false. (d)
Statement 2 is true and Statement 1 is false.
5. Read the following statements carefully:
{CBSE, Sample Paper 2022-231
Statement 1: Net investment is a stock concept.
Statement 2: Capital is a flow concept.
Alternatives:
(a) Statement 1 is true and Statement 2 is false. (b)
Statement 2 is true and Statement 1 is false.
(c) Both the statements are true. (d) Both the statements are false.
Very Short Answer Type Questions (VSAQs)
Q. 1. What is meant by circular flow of income?
Ans. Circular flow of Income refers to cycle of generation
of income in the production process, its distribution
among the factors of production and finally, Its circul
ation from households to firms in the form of
consumption expenditure on goods and services produ
ced by them.
Q. 2. Whatethethree phases of circular flow of incom
e?
Ans. Generation Phase; Distribution Phase and Dispo
sition Phase.
>
Chapter 1 ■ Circular Flow of Income

Q. 3. Define Macroeconomics.
Ans. Macroeconomics Is that part of economic theory which studies the behaviour of the aggregates of an
economy as a whole.

Q. 4• What are stock variables? {CBSE, All India 20 11, Delhi 20 12, 2016)
Ans. Stock variables refer to the variables, which are measured at a particular point of time.
Q. s. Define flow variable. {CBSE, Delhi 20 11, Alf India 20 12, 2016}
Ans. Flow variable refers to that variable, which is measured over a period of time.
Q. 6, ts national income a stock concept or flow concept?
Ans. National income is a flow concept as It is measured over a period of time.
Q. 1. What are the two types of circular flows?
Ans. n,e two types of circular flows are: (i) Real flow; (ii) Money flow.
Q. a. What is meant by real flow or physical flow?
Ans. Real flow or physical flow refers to the flow of factor services from households to firms and the corresponding
flow of goods and services from firms to households.

Q. 9. Define nominal flow. {CBSE, Sample Paper 2017}

Ans. Money flow or nominal flow refers to the flow of factor payments from firms to households for their factor
services and the corresponding flow of money, from households to firms, in the form of consumption
expenditure on the purchase of goods and services produced by the firms.

Q. 10. Name the two sectors in which real flow takes place in a simple economy.
Ans. (i) Household Sector, (ii) Firm Sector.
Q. 11. Give any two examples of flow concept. {CBS£, Delhi 2019}
Ans. (i) National Income; (ii) Investment.
Q. 12. What is the function of households in the circular flow (two-sector model)?
Ans. Households supply factor services to the firms and spend their entire income on the consumption of goods
and services produced by the firms.

Q. 13. Give two examples of macroeconomic studies.

Ans. (i) National income; (ii) Price level.

Ill REVISION EXERCISE

Short Answer Type Questions

1, Explain the circular flow of income. {CBSE, Delhi 2009, Delhi Comptt. 2014, AII India 20 17 (JI)}
OR
Explain Circular Flow of Income in a two sector economy. {CBSE, 2020 (58/5/ 1)}
2. Briefly explain the different phases of circular flow of income. {CBSE, 2022 (5814/ 1) Term-2}
3, What Is meant by circular flow of Income? Distinguish between Real Flow and Money Flow.
{CBSE, Delhi 2003}
4. 1blseholds and Firms depend on each other in the circular flow of income: Justify the statement in case
■IWo-sector model.
 Introductory M
acroec
C)~()
5. Distinguish between stocks and flows. Give an example of each. ~~I-
{CBS£ Foreign 2010, All India 2013, 2017 (Ill), Delhi 2018,
. 2022
6. Discuss briefly the circular flow of income in a two sector economy wi th the (S81s;
,
help of a su·t b 1J 'e,~ .
i a le . ·<1
" . .
7. Circular Flow of Income principle is based on the assumption - ones, expenditure
. ~CBSE, Sarnpte
1s other's.
Pa~:g,~\
2o ~
.
the given statement. 1
rncoro •
{CBSE, Delhi &Al e. J~stit,
a. Discuss the meaning of Macroeconomics. Give suitable examples. Con, .,y
Ptt. 2oi
1I
Long Answer Type Questions
1. Briefly explain the money flow and the real flow of income.
2. Describe the circular flow of income in a two-sector economy.
3. Differentiate between Microeconomics and Macroeconomics.
p

chapter 1 Circular Flow of Income

ANSWERS OF OBJECTIVE QUESTIONS

Fill in the Blanks

6. Physical flow
1• Disposition, Firms 11. Flow
• Government, Foreign 7, Firms, Households 12. Nominal Flow
2
3, Stock 8. Goods, Services 13. Stock
4, Real 9, Money Flow 14. Macroeconomics
s. Flow 10, Distribution

True or False
is measured over a period
1• ~ .!• Capital formation 6. F I '! . Even in case of closed economy, circular
of time. flow of income (i.e. three phases of generation,
distribution and disposition) takes place between
2• f ~-Money flow is known as nominal flow. Real
households and firms.
flow is known by the name of physical flow.
7. .,.rue. A closed economy is the one which has
phases (generation,
3, - ·~~-There are 3 different no economic relations with the rest of the
distribution and disposition) in circular flow of world. Accordingly, there are no exports in this
income. economy.
4, :- "e. It happens because firms sell their entire 8. .,.•ue. It is a stock variable as it is measured at a
output to the households. point of time.
s. s: i.-e. It is a flow concept as it is measured over 9. F1l~e. It comes under the purview of micro-
a period of time. economics.

Matching Type Questions

1. (c) Real Flow- (iii) It is also known as 3. (i) b; (ii) a.
Physical Flow. 4. (i) b; (ii) c; (iii) d; (iv) a.

2, (i) b. 5. (i) c; (ii) a.

Multiple Choice Questions (MCQs)

6. (b) 11. (d) 16•. (a) 21. (a) 26. (b)
1, (d)
12. (a) 17. (c) 22. (c) 27. (d)
2. {b) 7. (b)
13. (a) 18. (d) 23. (a) 28. (c)
3. (c) 8. (a)
9. {c) 14. (c) 19. (b) 24. (c)
4. {a)
20. (c) 25. (b)
s. (b) 10, (b) 15. (d)

Assertion Reason Questions (ARQs)

3. (b) 4. (d) 5. (a)
1, (a) 2. (c)

IIIICI Questlons
3. (d) 4. (b) 5. (d)
2, (a)
 Introductory Macroeconomics

\mmmom :111mmnoom I
1. CIRCULAR FLOW IN ATWO-SECTOR ECONOMY (WITH FINANCIAL MARKET)
Circular Flow in a two-~l'Ctor economy without the finnncial market assumed th~t there ar_e no
savings, i.e., households spend thl'ir entire income on purchase of goods and services and firm.~
spend all the ~ipts from sale of goods rind services in making foctor payments.
But, in actual practice, households do not spend their entire income on consumption, i.e., a part
of their income is saved. Similarly, firms also save some part of their receipts for expansion or
other reasons. Firms also borrow money to finance their expansion programmes. All savings
and borrowings are channelised through a financial market. Financial market refers to institutions
such as banks, insurance companies etc., which transact in loanable funds. Savings of households
accumulated in the financial market are utilised by firms for investment purposes. So, the
circular flow of income continues as shown in the following diagram:
fac;tor Services
f, Capital and
ptionExpen
dsand Ser

: _ Savings
HOUSEHOLDS Savings FlnancIaI 1
____;;.__
FIRMS
Market ,
Borrowings

OOdsandS

Fig.1.5

2. CIRCULAR FLOW IN A THREE-SECTOR ECONOMY

Circular flow of income in a three-sector economy consists of households, firms and the
government sector. Government plays a very important role in the economic development of a
country. It acts as both consumer and a firm. As a consumer, it spends on consumption of goods
and services produced by firms. As a producer, it produces goods and services for the economy.
In addition to flows of circular flow in two-sector economy with financial market, the
introduction of Government leads to following flows:
• Between Households and Government: Money flows from government to households in
the form of: (i) Transfer payments like scholarships, old age pension, etc.; and (ii) Factor
payments for hiring factor services of households.
chapter 1 ■ Circular Flow of Income

Money flows bark to the government from households in the form of din•ct tflxeRlike income
ta~ intere~t tax, rte.
, Brtwren Firms n"d Governmrut:: Money flows from firm s in the form of direct taxe~ and
indirect taxes.
Money flows to the firm s from govemmcnt, when the Jnttcr grnnts subsidies and makes
payment to the former for purchase of goods and services produced by the firm s.
A part of the income earned by government is also saved and deposited in the financia l
market. Government also borrows money from the financial market to meet its expenditure.
A brief summary of this circular flow is given in the following diagram:

1---=-•
IHI
Financial Savings
Market
Borrowings

Fig. 1.6

3. ROLE OF GOVERNMENT SECTOR IN AN ECONOMY

Government Sector performs the following activities in the economy:
(a) Government collects taxes from households and firms.
(b) Government makes transfer payments to the households and provides subsidies to the
firms.
(c) Government makes the payment for purchase of goods and services from the firms.
(d) Government saves and borrows money with the help of financial market.

4. CIRCULAR FLOW IN A FOUR-SECTOR ECONOMY

Circular flow of income in a four-sector economy consists of households, firms, government
and foreign sector. The various money flows in each sector are:
• IIDr,sehold Sector: Households provide factor services to firms, government and foreign
ledor. In return, it receives factor payments. Households also receive transfer payments from
govemment and the foreign sector. Households spend their income on: (i) Payment for
and services purchased from firms; (ii) Tax payments to government; (iii) Payments
 Introductory Macroecono .
n·ucs
• Finns: Firms receive revenue from households, government aocl th
e foreign sector for saJ
of their goods and services. Firms also receive subsidies from th e gover
nment. Firm make:
payments for: (i) Factor services to households; (ii) Taxes to the gover
nment; (iii) Imports
to the foreign sector.
• Government: Government receives revenue from firms, households
and the foreign sector
for sale of goods and services, taxes, fees, etc. Government makes
factor payments to
households and also spends money on transfer payments and subsid
ies.
• Foreign Sector: Foreign sector receives revenue from firms, house
holds and government
for export of goods and services. It makes payments for import of goods
and services frorn
firms and the government. It also makes payment for the factor services
to the households.
The savings of households, firms and the government sector get accum
ulated in the financial
market. Financial market invests money by lending out money to house
holds, firms and the
government. The inflows of money in the financial market are equal
to outflows of money. It
makes the circular flow of income complete and continuous. The circul
ar flow of income in a
four-sector economy is shown in Fig. 1.7.

Savings .,
im
Flnandal 111
Savings
Market Borrowings

Fig. 1.7

5. SIGNIFICANCE OF CIRCULAR FLOW OF INCOME

Study of circular flow of income is important due to the following reasons:
1. It helps us to understand the mutual interdependence among differ
ent sectors of the
.economy namely household sector, producer sector, government sector
and foreign
sector. It shows that all the sectors are complementary to one another in such
a way that
'the economic activity remains intact.
►

(hapt« , • Cirrnl,n Fk,w of Income

: . It ~ht'"'~ tlw '-'luihbtium pl,sith 1n of tlw tYmH1m~·. If tht'fl' I:,. ,rn y disl11r ti1111 111 thr c:l rrnl Jr
t1(,w. tlw ._,, ,1wmy will b'-' in di~t'tp1ilibrium 1md tlw i-mnoth functlnning of till' C'ronomy
,, ill l'\' dbturl't,t
3. lt lwlps in idt•ntifyin~ \',uious typt•s l 1 f ll',1k,,~t.'s ,rnd injections in th r l'conom y.
-l. It h\.·lps in \.'Stim,,tit.1n of n.1tion,1I inconw. Cin:: ul.u flow ~hows the three ph,1sLS of fl ow1

ot in1.,)mt? (gcncr,1tion, dbtributitlt\ and dispo~i tion ). It f,id lit,1tl'g dl'lerm ination of three
,iith.•n•nt ways (producth.m, income and e:\pl.'nditure methods) in which Uw flow of income
can be me.1sut'\.3\.l.

6. LEAKAGES AND INJECTIONS

Leakages
Lcak£Jgrs n:fcr to il'i tllflrt1wdl of mo11cy from the circulnr flow . When households and firms
saw a part of their incomes, it leads to a leakage from the circular flow of income. Leakage
or ";thdrawa.l refers to that part of income, which does not pass through the circu lar flow of
in(001e. As a result, it is not available for spending on currently produced goods and services.
It means, leafages reduce theJlow of Income.
Examples of Leakages in different types of Economies
1. Two-sector economy (without Financial Market) »» No Leakage
z. Two-sector economy (with Financial Market) »» Savings
3. Three-sector economy »» Savings + Taxes
4. four-sector economy »» Savings+ Taxes + Imports

Injections
Injection refers to the introdttction of income into the circular flow . When households and firms
borrow money from external sources like financial institutions, it adds to their income. Such
additional income does not result in immediate expenditure. So, injections increase theflow of income.
Examples of Injections in different types of Economies
1. Two-sector economy (without Financial Market) »» No Injection
2 Two-sector economy (with Financial Market) »» Investment
3. Three-sector economy »» Invesbnent + Govt. Exp.
4. Four-sector economy »» Investment + Govt. Exp . + Exports

I 1t must be noted that Equilibrium is achieved when Injections are equal to Leakages.