Understand how goods, services, and money circulate continuously between households and firms — the foundation of all national income analysis.
The circular flow of income describes the continuous movement of goods, services, and money payments between the different sectors of an economy. In the simplest two-sector model, households supply factors of production to firms and receive factor incomes (wages, rent, interest, profit) in return, while firms produce goods and services that households purchase with their income. This creates two simultaneous flows — a real flow of goods and factors, and a money flow of incomes and expenditures moving in the opposite direction.
As the model expands to three sectors (adding government) and four sectors (adding the rest of the world), injections and leakages become central concepts. Injections — investment (I), government expenditure (G), and exports (X) — add to the income stream, while leakages — saving (S), taxes (T), and imports (M) — withdraw from it. The equilibrium condition for a four-sector economy is I + G + X = S + T + M, a formula that is frequently tested in CBSE board exams both as a concept and as a numerical.