Three Phases in Circular Flow of National Income. There are three different phases in circular flow of national income, viz. production, income and expenditure. They represent three related aspects, namely, production (i.e., generation of income), distribution (of income) and disposition of income (i.e., expenditure). How? Production of goods and services is the result of combined efforts of factors of production (land, labour, capital and enterprise). The net output emerging from production process gets distributed in the form of money income (rent, wages, interest and profit) among factors of production for rendering productive service in the production of output. Thus production generates income or production flow gives rise to income flow. Income creates demand for goods and services. With this income factors of production purchase goods and services for final consumption and investment. Thus income creates expenditure or income flow gives rise to expenditure flow. Expenditure by households in turn leads to further production by producers as there is demand for new products. In this way income is generated, distributed and spent. Mind, circular flow of production, income and expenditure does not end here because expenditure, in turn, gives rise to further production. This leads to continuous circular movement of production income and expenditure. In short, production generates income, income creates expenditure and expenditure, in turn, calls forth production. Thus incomes which originate in production units ultimately come back to them by way of expenditure on goods and services by factor owner. This makes the circular flow of production, income and expenditure complete as shown in the Fig.(a).
Fig.(a).
Circular flow of production, income and expenditure
We can look at national income from three angles — as a flow of goods and services, as a flow of income or as a flow of expenditure.
Methods of Measurement. In fact methods of measurement of national income originate from three different phases in circular flow of national income. Corresponding to the above-mentioned three phases, there are three methods of measuring national income as shown below.
(i) Value Added Method (Traditionally called Production Method)
(ii) Income Method
(iii) Expenditure Method.
Since the above three methods are only different view points of the same flow of goods and services, totals from each method should, therefore, be equal to each other. We now take up each method one by one and try to understand the procedure involved in each method. In every method, we first estimate Domestic Income and then derive National Income by adding net factor income from abroad to domestic income.
