Fortunately, some of Sandra's payment is left over as income to Ben.Ī simple model excludes the government, but when the government is added the flows are altered, but income still equals expenditures. His purchase is an expense to Ben, but income to the auto parts store. Ben also purchases parts from a local auto parts store. George's wages are income to George, but an expenditure to Ben. Ben uses some of Sandra's payment to pay George. In other words, one person's expenditure is another entity's income. The circular flow model illustrates how in an economy income must equal production. Figure 1 illustrates how households and businesses interact in the goods and services and factor markets in exchange for money. The goods and services market is anywhere businesses sell goods and services to the final consumer. These factors include entrepreneurs, land, natural resources, labor, and capital. The factor market is where businesses go to purchase the items needed to produce goods or services.

They trade with each other in two markets-the factor market and the goods and services market. The two major actors in the circular flow model are households and businesses. This diagram depicts how goods and services flow in exchange for money. The circular flow model is a model that depicts how goods and services flow in exchange for money.Įconomists use the circular flow model to show the interdependent relationships between households, producers (businesses), and government. View FREE Lessons! Definition of the Circular Flow Model:

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