The Circular-Flow Model

By Jodi Beggs, About.com Guide

When factor markets are put together with goods and services markets, a closed loop for the flow of money is formed. As a result, continued economic activity is sustainable in the long run, since neither firms nor households are going to end up with all of the money. (It’s also worth noting that firms are owned by people, and people are parts of households, so the two entities are not quite as distinct as the model implies.)

The outer lines on the diagram (the lines labeled “Labor, capital, land, etc.” and “Finished product”) also form a closed loop, and this loop represents the fact that firms use factors of production to create finished products and households consume finished products in order to maintain their ability to provide factors of production.

Previous

• The Circular-Flow Model
• Goods and Services Markets
• Markets for the Factors of Production
• The Two Types of Markets Form a Closed Loop
• Models Are Simplified Versions of Reality
• Households Can Provide Things Other Than Labor

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