THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

Reported by: JOELO F. RODRIGUEZ

microeconomics report n0. 5
BSEd- Social Studies 2
 THE CIRCULAR FLOW OF ECONOMIC ACTIVITY

What Is the Circular Flow Model in Economics?

The circular flow model is an economic model that shows the flow of money
through the economy. The most common form of this model shows the circular flow of
income between the household sector and the business sector. Between the two are
the product market and the resource market.

Households purchase goods and services, which businesses provide

through the product market. Businesses, meanwhile, need resources in order to
produce goods and services. Members of households provide labor to businesses
through the resource market. In turn, businesses convert those resources into goods
and services.

4 Factors of Production

1. Labor- These are workers. The factor payment for labor is referred to as “wages.”

2. Land- This includes land that is rented or purchased, as well as other components like
natural resources and raw materials. The factor payment for land is referred to as “rent.”

3. Capital- This is money used to buy the tools that labor implements to convert land (i.e.,
natural resources) into goods. The factor payment for capital is called “interest.”
4. Entrepreneurs- These are the people who put the other three resources together to create a
successful business. The factor payment for entrepreneurs is called “profit.”

How Do Costs, Revenue, and Consumer Spending Relate to the Circular Flow
Model?

In the simple circular flow model of the free market, money flows in the opposite
direction.

Here’s how it works:

• When households need a good or service, their money flows to the product
market in a process called consumer spending.

• To provide goods and services to households, the product market purchases

them from businesses, generating revenue.

• To make goods and services for the product market, businesses purchase
resources from the resource market, generating cost.

• Finally, to generate resources businesses need to create goods, the resource

market pays for other resources—namely, workers and land. This
generates income for labor and landholders.

This is the basic circular flow diagram.

Consumer spending —> Revenue —> Cost —> Income

“As consumers, we have so much power to change the world by

just being careful in what we buy.”
-Emma Watson