CASE STUDY: Under circular flow of income in two sector economy, households are the owners of factors of production, they provide factor services to the firms to which firms provide factor payments in exchange of their factor services. Factor payments flow from firms to households. Households purchases goods and services from firms for which they make payments to them. So, consumption expenditure flows from households to the firms. There are 2 types of flows involved i.e. Real flow and Money flow. Real flow refers to the flow of goods and services across different sectors of the economy. For example: labour, capital, enterprise, land flowing from household to firms. Whereas, money flow refers to flow of factor payments and payments for goods and services between household and firms. It refers to the flow of money across different sectors of the economy. It is called money flow because it is through money that various transactions take place. For example: rent, wages, interest, profits etc. 

Which of the following describes a phase of circular flow of income?

Phase of expenditure

The phases of circular flow of income are:

• Phase of production: It is the phase where value addition is being done by the producing sector.
• Phase of income generation: This phase is about the factor payments received by the household sector in return to the services provided. In this phase there is generation of income.
• Phase of expenditure: Income is spent on purchase of final goods and services. In this phase there is disposition of income as an outcome of generation of income in phase 2.