APMacro: Circular Flow Model

Circular Flow Earnig a Living

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 resource market is the place where resources or the services of resource suppliers are bought and sold. In the resource market, households sell resources and businesses buy them. Households own all economic resources either directly as workers or entrepreneurs or indirectly through their ownership of business corporations. They sell their resources to businesses, which buy them because they are necessary for producing goods and services. The funds 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.

The lower part of the diagram represents the product market. The product market is 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 suggests a complex inter-related web of decision making and economic activity involving businesses and households. Businesses and households are both buyers and sellers. Businesses buys resources and sell products. Households buy products and sell resources. As shown in the diagram, there is a counterclockwise real flow of economic resources and finished goods and services, and a clockwise money flow of income and consumption expenditures. These flows are simultaneous and repetitive.

1. APMacro – Read Chapter 2 pp.29-41 – due Monday 2/1



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