The Circular Flow Model by Omkar Abhyankar

 In this article we are going to take a look at how money flows in an economy. We are going to take a look at a model known as the circular flow model to understand how money flows between different groups in an economy.

The Circular Flow Model:

This model outlines how money flows between two groups in an economy, businesses and households. The first group “businesses” considers all the firms in an economy. The second group, “Households”, considers the people inside the economy. Let’s analyze what both groups are doing in this model. First, let’s look at what businesses are doing in this model. Each arrow in the model represents what each of the two groups are sending and receiving. An arrow pointing towards one of the two groups means that the group is receiving the item labeled on the arrow. An arrow pointing away from one of the two groups means that this group is sending the items labeled on the arrow. Starting on the side labeled “Businesses” of our model, based on the arrows, we can see that businesses are sending their goods and services to a market called “The Product Market”. This is the market which we go shopping in. Target, Best Buy, Shoprite and other stores are all examples of a product market. From the product market, we see that those goods and services are sold to households, the people in the economy. In exchange for these goods and services, households give money to the product market. Finally, from the product market, that money is sent to the businesses responsible for producing the good or service. This money which the businesses received is their revenue from producing. Businesses can now spend their revenue by purchasing essential resources from the Resource Market to further enhance their business. 

Now looking at the second half of this model, let’s start off by looking at households. Recall that households consist of the people in the economy. As we can see from the diagram, households provide resources to a market called the “Resource Market”. Specifically, households or the people of the economy are providing the four factors of production (land, labor, capital and entrepreneurship) in the resource market. Then, businesses purchase these resources from the resource market. After making the purchase, businesses give their money to the resource market which ultimately sends that money back to the households. This money which the households receive is their income which they can now use to purchase goods and services back from the product market. As we can see from this model, money is circulating between households and businesses as one group sends money to another group, and the other group eventually sends it back.