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Circular Flow of Economic

The circular flow model illustrates how money and goods move in a circular fashion between businesses and households in a market economy. Businesses sell goods to households in exchange for money, while households sell factors of production like labor, land, and capital to businesses. This circular flow of money and goods between the two groups is determined by supply and demand and allows the overall economy to function.

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8 views

Circular Flow of Economic

The circular flow model illustrates how money and goods move in a circular fashion between businesses and households in a market economy. Businesses sell goods to households in exchange for money, while households sell factors of production like labor, land, and capital to businesses. This circular flow of money and goods between the two groups is determined by supply and demand and allows the overall economy to function.

Uploaded by

aiza corpuz
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Circular Flow of Economic Activity

What It Means
All market economies are characterized by a circular flow of
economic activity. This means that money and products
(including the products businesses need to operate) move in a
circular fashion between businesses and households. This
situation is often illustrated using a diagram that allows us to
visualize the basic workings of the overall economy.
A market is any place or system allowing buyers and sellers to
come together. A market economy is one in which the free
interaction of buyers and sellers determines most of the
important features of economic life. Most economic decisions in
a market economy are based on the forces of supply (the
amount of any good or service that a seller is willing to sell at a
given price), demand (the amount of any good or service that
buyers are willing to buy at a given price), and prices. Sellers
tend to supply more and more of their products as prices rise
(because they want to maximize their profits), while buyers tend
to buy less and less of a product as prices rise (because they
want to maximize their own economic well-being). When buyers
decide to purchase or not purchase certain goods in certain
quantities, sellers make corresponding decisions about what to
supply and in what quantities.
The circular flow model illustrates how market forces determine
the overall shape of the economy. Businesses and households
act as both buyers and sellers in the economy. Businesses sell
products to households in exchange for money, and households
sell products called the factors of production (land, labor, and
capital [money and equipment], the resources required to do
business) to businesses. The inner circle of the model shows
products and services moving clockwise between businesses
and households. The outer circle of the model shows income
(money) moving counterclockwise between businesses and
households.
This model is a simplification of economic activity, but it allows
us to understand some central facts about market economies.
Businesses and households are dependent on one another.
They are bound to one another by supply and
demand relationships that, in being played out, dictate the
working of the economy. The money that households use to
satisfy their needs and wants comes from businesses, and the
money that businesses need in order to operate comes from
households. Likewise, the products that households need and
want come from businesses, and the factors of production that
businesses need in order to operate come from households.

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