Circular flow of income refers to the continuous circulation of production, income generation and expenditure involving different sectors of the economy. Phases of Circular Flow of Income There are three different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram:
(i) Production phase In this phase, firms produce goods and services with the help of factor services.
(ii) Income phase This phase involves the flow of factor income (rent, wages, interest and profits) from firms to the households.
(iii) Expenditure phase In this phase, the income received by factors of production, is spent on the goods and services produced by firms.
Income is first generated in production units, then distributed to households and finally spent on goods and services produced by these units to make the circular flow complete its course.