A description of the circular flow model of economics

Unemployment Analysing the economic relationship between households and firms The household is the basic unit of analysis in many social, microeconomic and government models.

A description of the circular flow model of economics

Circular Flow of Income: Let us make in-depth study of the circular flow of income in two sector, three sector and four sector economy. Real flows of resources, goods and services have been shown in Fig.

In the upper loop of this figure, the resources such as land, capital and entrepreneurial ability flow from households to business firms as indicated by the arrow mark. In opposite direction to this, money flows from business firms to the households as factor payments such as wages, rent, interest and profits.

In the lower part of the figure, money flows from households to firms as consumption expenditure made by the households on the goods and services produced by the firms, while the flow of goods and services is in opposite direction from business firms to households.

Thus we see that money flows from business firms to households as factor payments and then it flows from households to firms. Thus there is, in fact, a circular flow of money or income. This circular flow of money will continue indefinitely week by week and year by year.

This is how the economy functions. It may, however, be pointed out that this flow of money income will not always remain the same in volume. In other words, the flow of money income will not always continue at a constant level.

What is the 'Circular Flow Of Income'

In year of depression, the circular flow of money income will contract, i. This is so because the flow of money is a measure of national income and will, therefore, change with changes in the national income. In order to make our analysis simple and to explain the central issues involved, we take many assumptions.

In the first place, we assume that neither the households save from their incomes, nor the firms save from their profits.

Circular flow of income

We further assume that the government does not play any part in the national economy. In other words, the government does not receive any money from the people by way of taxes, nor does the government spend any money on the goods and services produced by the firms or on the resources and services supplied by the households.

Thirdly, we assume that the economy neither imports goods and services, nor exports anything. In other words, in our above analysis we have not taken into account the role of foreign trade.

In fact we have explained above the flow of money that occurs in the functioning of a closed economy with no savings and no role of government. Circular Income Flow with Saving and Investment: In our above analysis of the circular flow of income we have assumed that all income which the households receive, they spend it on consumer goods and services.

A result, circular flow of money speeding and income remains undiminished. We will now explain if households save a part of their income, how their savings will affect money flows in the economy.

With reduced money receipts, firms will hire fewer workers or lay off some workers or reduce the factor payments they make to the suppliers of factors such as workers.Circular-Flow Diagram a visual model of the economy that shows how dollars flow through markets among households and firms This model shows how households and firms interact in the markets for goods and services, where households buy goods and services from firms.

Circular Flow Model. View FREE Lessons! Definition of the Circular Flow Model: The circular flow model is a model that depicts how goods and services flow in exchange for money. Detailed Explanation: Economists use the circular flow model to show the interdependent relationships between households, producers (businesses), and .

Let us make in-depth study of the circular flow of income in two sector, three sector and four sector economy. Circular Income Flow in a Two Sector Economy: Real flows of resources, goods and services have been shown in Fig. Building up the model. In this next series of images we build up the circular flow model from just having a domestic sector and then adding in an external sector (exports and imports) before including the financial sector which channels savings and hopefully provides the finance available to fund investment.

Apr 04,  · Economic Model #1: The Circular-Flow Diagram One model that helps explain how a market economy works is a circular-flow diagram. A circular-flow diagram is a visual model of the economy that illustrates how households and businesses interact through markets for products and markets for resources.

Circular Flow Model - Economics. Description. These cards deal with the Circular Flow Model of Economics. Total Cards. Subject. Economics. Level. 12th Grade.

A description of the circular flow model of economics

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