What is a circular flow of income?

The circular flow of income is the basic accounting model that helps to demonstrate the influx of income and the relationship of this flow to the general economy. To create this model, it is necessary to make several basic assumptions that are considered likely. Although this approach to understanding the general movement of money can help provide an overview of the economy, many analysts consider this model one of several tools necessary to fully grasp the state of income in a given set of circuits.

The development of a circular revenue flow for a given situation requires several basic prerequisites. First, it is assumed that the economy is composed of two basic components, sometimes defined as households and companies. In some models, they are referred to as residential and business sectors. Furthermore, the model will not deal with the existence of an international component, government component or sector that deals with financial services. In short, they will focus on the relationship between income obtained from companies and how households use this income to nákupu goods and services offered by the company.

While calculating a circular flow of income can be useful in demonstrating the strength or weakness of domestic goods to meet the needs of domestic customers, the model is very limited. The reason is factors that are not considered part of the model. For example, it is assumed that household income flow is complete. There are no provisions for households that would decide to save part of the income in some form. The model also assumes that all products produced by companies are really consumed by household households. A typical model for circular flow of income also does not take into account taxes and similar expenses that absorb part of the revenue flow of any household.