National Income

The circular flow of income
 

• The circular flow of income is a model showing how money circulates from firms to households and back again.
  
  
• Households provide the land, labour and capital required in order for firms to produce goods and services (national output). These are given back to the households (national income) and so the cycle continues.
  
  
• Firms give income to the households and households spend money (national expenditure) on goods and services so that the money flows back to businesses. This is the circular flow of income and it is depicted in the diagram below.

​

• The circular flow of income can also be shown by the formula:
  National Output = National Income = National Expenditure
  
  
• The two flows on the diagram are the physical and monetary flow. Physical flow is of ‘real objects’ (depicted by the thin arrows) whereas the monetary flow is the money that pays for these ‘physical things’ (depicted by the thick arrows).

 
The distinction between income and wealth
 

• Wealth is the actual value of the assets owned and is defined as the sum of all assets in the economy; it is a stock concept (not currently being used in the circular flow). Income on the other hand is a flow concept.
  
  
• Changes in wealth have an effect on incomes and spending, this usually happens when assets such as houses change in price. The concept is called the wealth effect.