Circular Flow of Income in a Four-Sector Economy!

Circular flow of income in a four-sector economy consists of households, firms, government and foreign
sector.

Household Sector:
Households provide factor services to firms, government and foreign sector.
In return, it receives factor payments. Households also receive transfer payments from the government and
the foreign sector.

Households spend their income on:

(i) Payment for goods and services purchased from firms;

(ii) Tax payments to government;

(iii) Payments for imports.

Firms:
Firms receive revenue from households, government and the foreign sector for sale of their goods and
services. Firms also receive subsidies from the
government.

Firm makes payments for:

(i) Factor services to households;

(ii) Taxes to the government;
(iii) Imports to the foreign sector.

Government:
Government receives revenue from firms,
households and the foreign sector for sale of
goods and services, taxes, fees, etc.
Government makes factor payments to
households and also spends money on transfer
payments and subsidies.

Foreign Sector:
Foreign sector receives revenue from firms, households and government for export of goods and services. It
makes payments for import of goods and services from firms and the government. It also makes payment for
the factor services to the households.

The savings of households, firms and the government sector get accumulated in the financial market.
Financial market invests money by lending out money to households, firms and the government. The
inflows of money in the financial market are equal to outflows of money. It makes the circular flow of
income complete and continuous. The circular flow of income in a four-sector economy is shown in Fig. 1.7.
Circular Flow of Income in a Four Sector Economy.
 Money meaasures supply in india

There are four measures of money supply in India which are denoted by M1, M2, M3 and M4.
This classification was introduced by the Reserve Bank of India (RBI) in April 1977.

M1. The first measure of money supply, M1 consists of:

(i) Currency with the public which includes notes and coins of all denominations in circulation
excluding cash on hand with banks:

(ii) Demand deposits with commercial and cooperative banks, excluding inter-bank deposits;
and

(iii) Other deposits with RBI which include current deposits of foreign central banks, financial
institutions and quasi-financial institutions such as IDBI, IFCI, etc., other than of banks, IMF,
IBRD, etc. The RBI characterizes as narrow money.

M2. The second measure of money supply is M2 which consists of M1 plus post office savings
bank deposits. Since savings bank deposits of commercial and cooperative banks are included
in the money supply, it is essential to include post office savings bank deposits. The majority
of people in rural and urban India have preference for post office deposits from the safety
viewpoint than bank deposits.

M3. The third measure of money supply in India is M3, which consists of M1, plus time
deposits with commercial and cooperative banks, excluding interbank time deposits. The RBI
calls M3 as broad money.

M4. The fourth measure of money supply is M4 which consists of M3 plus total post office
deposits comprising time deposits and demand deposits as well. This is the broadest measure
of money supply.

Methods of measruing national income

1. Product Method:

In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final
goods here refer to those goods which are directly consumed and not used in further
production process.
Goods which are further used in production process are called intermediate goods. In the
value of final goods, value of intermediate goods is already included therefore we do not
count value of intermediate goods in national income otherwise there will be double counting
of value of goods.

To avoid the problem of double counting we can use the value-addition method in which not
the whole value of a commodity but value-addition (i.e. value of final good value of
intermediate good) at each stage of production is calculated and these are summed up to
arrive at GDP.

The money value is calculated at market prices so sum-total is the GDP at market prices. GDP
at market price can be converted into by methods discussed earlier.

2. Income Method:

Under this method, national income is measured as a flow of factor incomes. There are
generally four factors of production labour, capital, land and entrepreneurship. Labour gets
wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as
their remuneration.
Besides, there are some self-employed persons who employ their own labour and capital such
as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all
these factor incomes is called NDP at factor costs.

3. Expenditure Method:

In this method, national income is measured as a flow of expenditure. GDP is sum-total of

private consumption expenditure. Government consumption expenditure, gross capital
formation (Government and private) and net exports (Export-Import).