What is circular flow of national income?
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Answer:
The circular flow of income is a model that represents how money moves around in an economy. In a simple economy, we have only two components—households and industries. But it isn’t that simple.
In an open economy, there are a lot more factors that affect the circular flow of income. In addition to household consumption and business production, an open economy also takes into account the government spending and foreign trade.
Money is injected into the economy when the government invests money in infrastructure and welfare schemes. Similarly, industries and businesses also earn income when they export goods. However, when we import goods and services and pay taxes to the government, we reduce our spendable income.
Now government spending, exports, and investments together with household income (wages) constitute the influx of money into an economy. Similarly, business investments, taxes, and imports constitute the total outflow. The national income will increase when the total influx of money is more than the outflow of money. And the circular flow of income will be in balance when the total influx matches the total outflow.
