The circular flow of income is an economic model that reflects how money or income flows through the different sectors of the economy. A simple economy assumes that there exist only two sectors, i.e., Households and Firms. Households are consumers of goods and services and the owners of the factors of production (land labour, capital, and enterprise). However, the firm sector produces goods and services and sells them to households. There are two types of circular flows, namely Real Flow and Money Flow.
Real Flow
The flow of factor services from the households to the firms and the corresponding flow of goods from firms to the households in an economy is known as the Real Flow. Real flow is also known as Physical Flow. In this type of circular flow, there is no involvement of money, and the goods and services are exchanged between the two sectors of the economy. This flow helps an economy in determining the magnitude of its growth process. For example, if more factor services are provided to the firms, then they will produce more volume of production, which will ultimately speed up the process of economic growth.
Money Flow
The flow of factor payments from the firms to households for their factor services and the corresponding flow of consumption expenditure from households to the firms for the purchase of goods and services produced by the firms is known as Money Flow. Money flow is also known as Nominal Flow. This type of circular flow includes the exchange of money between the two sectors, i.e., households and firms.
Real Flow v/s Money Flow
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