Circular Flow of Economy

Submitted by:
Adrian C. Carbon
Zyron Española
Godfrey Parac

Submitted to:
Ms. Roalene Lumakin
The circular flow diagram is an abstraction of the
economy as a whole. The diagram suggests that the
economy can reproduce itself. The idea is that as
households spend money of goods and services from
firms, the firms have the means to purchase labor from
the households, which the households to then
purchase goods and services. Suggesting that this
process can and will continuously go on as a perpetual
motion machine.
The five-sector model adds the financial sector to the
four-sector model. Thus, the five-sector model includes
(1) households, (2) firms, (3) government, (4) the rest of
the world, and (5) the financial sector. The financial
sector includes banks and non-bank intermediaries that
engage in borrowing (savings from households) and
lending (investments in firms). Money facilitates such an
exchange smoothly. Residuals from each market enter
the capital market as savings, which in turn are
invested in firms and the government
sector. Technically speaking, so long as
lending is equal to borrowing the circular flow
will continue indefinitely.
• Household- is a person or a group of people living in
the same residence.
• Firms- is a central institution in the functioning of any
economic system in which people meet their needs
through the division of labor, cooperative production,
and the exchange of goods and services
• Government- Governments provide the legal and
social framework, maintain competition, provide
public goods and services, redistribute
income, correct for externalities, and
stabilize the economy.
• Rest of the world:
• a.Market for Factors of Production- "Factor market" is
a term economists use for all of the resources that businesses
use to purchase, rent, or hire what they need in order to
produce goods or services. Those needs are the factors of
production, which include raw materials, land, labor, and
capital. The factor market is also called the input market.
• b.Market for goods and services - the market for
goods and services is simply where the goods and services
produced by businesses are bought. So, in the markets for
goods and services, businesses sell goods and
services and households buy goods and
services. Goods and services are the output of an
economic system. Goods are tangible items sold to
customers, while services are tasks performed for
the benefit of the recipients.
• Financial Market- Financial markets refer
broadly to any marketplace where the trading
of securities occurs, including the stock
market, bond market, forex market, and
derivatives market, among others. Financial
markets are vital to the smooth operation of
capitalist economies.