Question

Which of the following is always equal to gross domestic income in the circular flow of income and expenditure? a. Net tax revenues b. net exports c. gross leakages d. gross domestic product

Answer 1

d. Gross domestic product.

The circular flow of income is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. As individuals and firms buy and sell goods and services, money flows among the different sectors of the economy. The circular flow of income describes these flows of money. From a simple version of the circular flow, we learn that, gross domestic product (GDP) = income = production = spending.

In the basic circular flow of income, the state of equilibrium is defined as a situation in which there is no change in the levels of income (Y), expenditure (E) and output (O) i.e. : Y = E = O. This means that the expenditure of buyers (households) becomes income for sellers (firms). The firms then spend this income on factors of production such as labour, capital and raw materials. The factor owners spend this income on goods which leads to a circular flow of income.