THE CIRCULAR FLOW MODEL

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.