THE CIRCULAR FLOW MODEL

2 May

Because nearly all of the major nations now use the market system, we need to gain a good understanding of how this system operates. Our goal in the remainder is to identify the market economy’s decision makers and major markets.

The market economy has two groups of decision makers: households and businesses. It also has two broad markets: the resource market and the product market
The upper half of the diagram represents the resource market: the place where resources or the services of resource suppliers are bought and sold. In the sources market, households sell resources and businesses purchases them. Households (that is, peo­ple) own all resources either directly as workers or entrepreneurs or indirectly through their ownership (through stocks) of business corporations. They sell their resources to businesses, which buy them because they are necessary for producing goods and services. The money that businesses pay for resources are costs to busi­nesses but are flows of wage, rent, interest, and profit income to the households. Resources therefore flow from households to businesses, and money flows from businesses to households.
Next consider the lower part of the diagram that represents the product market: the place where goods and services produced by businesses are bought and sold. In the prod­uct market, businesses combine the resources they have obtained to produce and sell goods and services. Households use the income they have received from the sale of resources to buy goods and services. The monetary flow of consumer spending on goods and services yields sales revenues for businesses.
The circular flow model shows the interrelated web of decision making and eco­nomic activity involving businesses and households. Businesses and households are both buyers and sellers. Businesses buy resources and sell products. Households buy products and sell resources. There is a counterclockwise real flow of resources and finished goods and services, and a clockwise money flow of income and consumption expenditures. These flows are simultaneous and repetitive

Key words:
Resource market -A mar­ket in which house­holds sell and firms buy resources or the services of resources.
Product market -A mar­ket in which prod­ucts are sold by firms and bought by households.
Circular flow model-The flow of resources from households to firms and of prod­ucts from firms to households. These flows are accompa­nied by reverse flows of money from firms to households and from households to firms.

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24 Responses to “THE CIRCULAR FLOW MODEL”

  1. John Liming July 1, 2012 at 8:18 PM #

    I have always maintained that everything flows according to natural patterns and this confirms that to me. That is very enlightening.

  2. andyknaster July 2, 2012 at 12:01 AM #

    You are spot on here. Now if the US government would abandon its corporatist ways, we might truly experience the values of a free market economy. Through corporatism, the government is effectively violating its own antitrust laws and hindering a free market economy because it is nearly impossible to compete against an entity that does not raise profits and can print its own money when its operating capital is running low.

  3. David Halliday July 7, 2012 at 2:42 AM #

    Its a nice diagram. 1. What about companies that produce nothing? They affect everything but they speculate. 2. What about infrastructure? Who pays for railroads, highways. 3. What about law and order? 4. Doesn’t business need an environment in which they can maximize their profits? Most companies need stability. But others need turmoil. It just seems too simplistic.

    • justdan93 July 7, 2012 at 10:47 AM #

      1. Since they produce nothing then they don’t produce anything, so there isn’t any consumer-supplier bond.No need to include them,
      2.I have a new flow model with government. It pays for public goods (https://justdan93.wordpress.com/2012/07/01/circular-flow-model-with-government/)
      3.Law is supplied again by government, order depends on the type of market system (pure comtition, pure monopoly, oligopoly, monopolistic competition)
      4.We don’t include the environment needed- because here we study the interactions between producers and consumer!
      Thanks for asking!

  4. aquacompass7 July 7, 2012 at 3:12 PM #

    From Japan. I think that Economy is important in order to understand the world.

    • justdan93 July 7, 2012 at 3:47 PM #

      You are right Sir. As any other science, economics helps us to understand how the whole world works!

  5. patrice345 July 8, 2012 at 2:23 AM #

    Great post, I remember this from one of my classes!

  6. Mario Campollo/Dos July 9, 2012 at 10:14 AM #

    super interesting i gotta get on the flow,HA!

  7. Grumpa Joe July 11, 2012 at 12:50 AM #

    I really don’t know why I like your explanation, but I do.

  8. neelkanth July 19, 2012 at 4:43 PM #

    So nice. I have since started following your blog. Thanks for your ‘like’ on my blog post.

  9. cinderellareleased July 21, 2012 at 8:45 PM #

    Reblogged this on cinderellareleased and commented:
    I really like this blog…check it out.

  10. mmoussa July 23, 2012 at 6:24 PM #

    Your blog is amazing!!!

  11. Bruce Meisterman July 24, 2012 at 12:41 AM #

    Hi,

    Your blog will certainly be a much needed education for me. Keep it up!

  12. devontexas July 24, 2012 at 8:18 PM #

    Excellent post. Makes much more sense than the “Give Tax Cuts to the so-call Job Creators and the Economy will be successful”.model.

  13. fgassette July 24, 2012 at 9:00 PM #

    I hope you are encouraged, inspired and enjoy the photos I take of everyday life and the events around it as I travel through my retirement years.

    BE ENCOURAGED! BE BLESSED!

  14. torimcrae July 25, 2012 at 1:06 PM #

    Thanks for your committment to helping we non-economists understand the concepts.
    Tori McRae

  15. 24/7 in France July 26, 2012 at 8:58 AM #

    Very interesting!

    • Leo July 27, 2012 at 7:15 AM #

      Life is cyclic as is the cosmos, so it will be with Industry.

  16. Patrice July 31, 2012 at 7:16 PM #

    Very interesting, informative writings you have here!

  17. Laurie August 1, 2012 at 7:54 PM #

    Love that you love economics! Been reading some of your posts and find them informative and helpful. Keep up the good work – so many don’t understand the basics. It’s good to be reminded – again!
    Every blessing,
    Laurie

  18. Nici Roberson August 2, 2012 at 1:26 AM #

    Wow I dont know what to say, other than i am definitely going to be sharing this with my husband when he gets home!!! thank you so much for this post!!!

  19. Thursday's Child August 3, 2012 at 12:23 AM #

    I am terrible with economics. Hubby does all the finances.
    Veronica

  20. Susan LaDue August 5, 2012 at 4:14 PM #

    Excellent post! You’ve helped me understand some economic dynamics that were a mystery.

  21. seashoes August 10, 2012 at 1:03 AM #

    I wish I could work out how to redirect some of the flow ( even a few drops) my way!

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