Readers Question I am having trouble understanding the circular flow of economics. Could you explain it in simple terms, like how is it involved in my life, I don’t get the connection to the product and factor markets
The circular flow of income is a simple model to explain basic economic transactions.
To start off, consider 2 groups of people
- Households – people like yourself
- Firms – companies like BMW, Vodafone e.t.c.
- Householders (people like you or me) could get a job in a factory making cars. This leads to an output of goods.
- In return, workers get income (wages) from the firm.
- With this income, we can buy the goods firms are producing. This is Expenditure.
Thus in a closed economy with no saving, tax or imports. Total Output should be the same as Total Income and Total Expenditure.
- Note: Factor markets are markets like labour markets.
- Product markets are the production of goods like cars
Therefore, this is the very basic circular flow of income.
Government tax and spending
- To this circular flow, you could add a government which collects taxes from firms and households.
- The government then spends this money in the form of benefits and subsidies.
Also, you could add a foreign dimension.
- Goods and services could be exported – Money comes into economy
- Goods and services could be imported – Money leaves the economy
Also, we don’t spend all the money we receive, but will save some in banks. Firms could borrow from banks to invest.
7 thoughts on “Circular Flow of Economic Activity”
You cycle omits the accumulation of capital, which means that income does not equal expenditure.
Becasue of this inequality inceasing levels of debt/leverage are require to maintain household income and make income equal to expenditure
put it simply: capital accumulation implies credit bubbles
that was really a very good way to teach circular flow
I think da diagram is ok
perfect lecture even an ordinary person will understand what we mean by circular flow of income you are my role model i which i can lecture like that
Really nice, dude. Like i tried to read from the professor’s notes, i couldn’t understand it very clearly. You gave a clear picture. thumbs up. 🙂
Thanks now I know it,,,I dont jst understand it better but I know it…surely I can explain 2 others..u r a star thank you tons
really nice, very simple and understandable.