Explain the Circular flow of income (Class 12)

It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them.

Phases of Circular Flow of Income

There are 3 different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram:

1. Generation Phase:

In this phase, firms produce goods and services with the help of factor services.

2. Distribution Phase:

This phase involves the flow of factor income (rent, wages, interest and profit) from firms to the households.

3. Disposition Phase:

In this phase, the income received by factors of production is spent on the goods and services produced by firms.

In this way, income generated in production units reaches back to production units and makes the circular flow complete.