The Circular Flow Model In economics, a circular flow model is a diagram that is used to represent the monetary transactions in an economy. There are two flows present within the model including flows of physical things (goods or labor) and flows of money (what pays for physical things). A circular flow model depicts the inner workings of a market system and specific portions of the economy. The concept the circular flow of income is a simplification which attempts to illustrate the flow of money and goods from households to business enterprise and back to households. We know that the economic activities and money have a circular flow. Circular flow ‘of money means that the money spent must not be hoarded and should continue to flow to maintain a certain Level of economic activity and income. In order to obtain a clear idea of the relations between the numerous economic units in a country, it is best to reduce them to homogeneous groups. The basic circular flow model consists of two sectors that determine income, expenditure, and output. A state of equilibrium is reached when there is no tendenoy for the levels of income (Y), expenditure (E), and output (0) to change (Y=E=0). This equation means that the expenditure of buyers (households) becomes income for sellers (firms). The firms spend the income on factors of production, which "transfers" the income to the factor ‘owners. The factor owners spend the income on goods which leads to the circular flow of payments. From the viewpoint of producers these transactions take the form of: () Purchase of the factor services from the household sector, (i) (i) Sale of final output to household sector. From the ‘consumers’ viewpoint, these transactions take the form of: (). Sale of factor services to business sector, (i) (i) Purchase of fnal output from business sectorASSUMPTIONS (a) The economy is a closed economy (no foreign trade sector), (b} Production takes place only in business sector, (c) Producers sell all that they produce. In other words, there is no inventory accumulation in the business sector, (@) Consumers spend all their income on consumption. In other words, there is 1no saving in the household sector, (@) There are no transactions involved like government expenditure on goods and ‘services or taxes etc. Given the above assumptions, it follows that production should equal sales and income should equal expenditure—the circular flow then is complete. The circular flow of payments is important within an economy because it 1) measures the national income, 2) provides knowledge of interdependence, 3) illustrates the unending nature of economic activities, and 4) shows injections and leakages.Expenditures: Expenditures. Goods andservices