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Introduction
The circular flow of income represents money moving through the economy. It shows how households purchase goods and services from firms by using the income they earned from firms by working for them. Firms use factors such as capital, labor, and land from households so they can produce the goods households purchase.

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Defination
The circular flow of income or circular flow is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. between economic agents. The flows of money and goods exchanged in a closed circuit correspond in value, but run in the opposite direction.

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Phases Of Circular Flow Of Income
There are three different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram:
(i) Production phase In this phase, firms produce goods and services with the help of factor services.
(ii) Income phase This phase involves the flow of factor income (rent, wages, interest and profits) from firms to the households.
(iii) Expenditure phase In this phase, the income received by factors of production, is spent on the goods and services produced by firms.

Income is first generated in production units, then distributed to households and finally spent on goods and services produced by these units to make the circular flow complete its course.

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Stock And Flow
The concepts of stock and flow are used in more in macro economics or in the theory of income, output and employment. Money is a stock variable, whereas the spending the money is a flow variable. Wealth is stock, income is flow, saving by a person within a month is flow, while the total saving on a day is stock.

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Difference Between Stock And Flow
Stock
(1) Stock means that quantity of an Economic variable which is measured at a particular point of time.
(2)Stock has no time dimension. .
(3)Stock is a static concept.
(4) Example : (a) Quantity of money
(b) Wealth'
(c) The Amount of wheat stored
(d) Water in a reservoir.
Flow
(1) Flow is that quantity of an economic Variable which is measured during the Period of time.
(2) Flow has time dimension as per hour, Per day, per month and per year.
(3) Flow is a dynamic concept.
(4) Examples : (a) Consumption
(b) Investment
(c) Income
(d) water in a river.

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Type Of Circular Flow
Circular flow is of two types
(i) Real flow shows flow of goods and services across different sectors.
(ii) Money flow (or income flow) shows flow of money across different sectors.

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Difference Between Real Flow And Money Flow.
Real Flow

Real flow is the exchange of goods and services between household and firms whereas money flow is the monetary exchange between two sectors.In real flow household sector supplies raw material, land, labour, capital and enterprise to firms and in return firms sector provides finished goods and services to household sector. Whereas in money flow, firm sector gives remuneration in the form of money to household sector a wages and salaries, rent, interest etc.

1. Difficulties of barter system for the exchange of goods and factor services between households and firms sector in real flow, whereas no such difficulty or inconvenience arise in money flow.

2. When goods and services flow from one sector of the economy to another, it is known as real flow.

Money flow
1.Money flow occur when companies pay wages in return for labor or services provided by individuals, as well as when individuals spend money to obtain goods or services produced by companies.
2. The flow of consumption expenditure from household to firm for the purchase of goods and services manufactured by the firm.

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Circular Flow Of Income In A Two Sector Economy

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Circular Flow Of Income In A Two Sector Economy

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The circular flow model in the two-sector economy is a hypothetical concept which states that there are only two sectors in the economy, household sector and business sector (business firms).The household sector is the source of factors of production who earn by providing factor services to the business sector. The business sector refers to the firms that produce goods and services, and receive income by supplying the produced goods to the household sector. The state of equilibrium in the two-sector economy is defined as a situation in which no change occurs in the levels of income (Y), expenditure (E), and output (O). i.e. Y=E=O
Assumptions
The two sector economy has the following assumptions:

1. There are only two sectors in the economy; household sector and business sector.

2. No government interventions over the economic activities.

3. Business sectors do not carry out any import or export activities, creating a closed economy.

On the basis of the assumptions, the two sector economy is explained with the help of the following diagram.

The outer circle represents real flow and the inner circle represents the monetary flow. Real flow indicates the factor services flow from household sector to the business sector, and goods and services flow from business sector to the household. Monetary flow illustrates that, in terms of money, factor rent, wage, interest and profit flows from the business sector to household sector. On the other hand, the consumption expenditure made by households flow to the business sector as revenue for the firms. This means that the expenses made by the households become the source of income for the business sector or the firms and vice versa. The firms provide payment to the factory owners for procuring factors of production. Further, the factor owners spend this income on goods and services produced by the business sector, which becomes revenue for the business sector. Since the households spend their income, the total monetary receipts of business sector will be equal to the income and consumption expenditure of the household sector. This means, monetary receipts of the producers = income of the households = consumption expenditure of the households. In this way, an equilibrium state exists in the economy where total demand equals total supply. Thus the circular movement of income and expenditure in the economy continues, leading to equalization in the gross national product and gross national income.