Circular flow of income refers to continuous circular flow of goods, services and incomeamong different sectors of an economy. Flow of money is the aggregate value of goods and services either as factor payments or as expenditure on goods and services. It is circular since it has neither any beginning nor an end. It can be explained as household sector supply factor services and spend their income on consumption. The firms use these services in producing goods and other services. The households as owner of factors for production receive the payments in terms of money or reward for rendering productive services. The recipients of these incomes (i.e. households) in turn, spend their incomes on purchase of goods and services to satisfy their wants. In short, income is first generated by production units, then distributed among households for rendering productive services and ultimately comes back to production units by way of expenditure by the households. Circular flow works on two principles :
(i) In an exchange process, the seller (producer) receives the same amount which the buyer (or consumer) spends.
(ii) Goods and services flow in one direction and the money paid to acquire them, flow in the reverse direction giving rise to a circular flow.