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Understanding Circular Flow in Economics

The document discusses the economic way of thinking and the circular flow model of the economy. It explains that economics distinguishes between positive and normative statements. The circular flow model shows the circular flows of expenditures and incomes resulting from decision makers' choices in markets. It depicts households and firms, markets for factors of production and goods, and the real and money flows between households and firms. Real flows involve households supplying factors to firms and firms providing goods to households, while corresponding money flows run in the opposite direction.

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9 views9 pages

Understanding Circular Flow in Economics

The document discusses the economic way of thinking and the circular flow model of the economy. It explains that economics distinguishes between positive and normative statements. The circular flow model shows the circular flows of expenditures and incomes resulting from decision makers' choices in markets. It depicts households and firms, markets for factors of production and goods, and the real and money flows between households and firms. Real flows involve households supplying factors to firms and firms providing goods to households, while corresponding money flows run in the opposite direction.

Uploaded by

Teteichhangte
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

1.

2 THE ECONOMIC WAY OF THINKING

Economics as a Social Science


Economists distinguish between
• Positive statements: What is
• Normative statements: What ought to be
The task of economic science:
To test positive statements about how the economic
world works and to weed out those that are wrong.
2.2 THE CIRCULAR FLOWS

Circular flow model


A model of the economy that shows:
the circular flow of expenditures and incomes that result
from decision makers’ choices and
the way those choices interact in markets to determine
what, how, and for whom goods and services are
produced.
2.2 THE CIRCULAR FLOWS

Households and Firms


Households
Individuals or people living together as decision-making
units.
Firms
Institutions that organize production of goods and
services.
2.2 THE CIRCULAR FLOWS

Markets
A market is any arrangement that brings buyers and
sellers together and enables them to get information
and do business with each other.
Factor markets are markets in which factors of
production are bought and sold.
Goods markets are markets in which goods and
services are bought and sold.
2.2 THE CIRCULAR FLOWS
Real Flows and Money Flows
In factor markets:

• Households supply
factors of production
• Firms hire factors of
production.
In goods markets:
• Firms supply goods and
services produced.
• Households buy goods
and services.
2.2 THE CIRCULAR FLOWS
Real Flows and Money Flows

These are the real flows in


the economy.

Money flows run in


the opposite direction
to the real flows.
2.2 THE CIRCULAR FLOWS
Real Flows and Money Flows
• Firms pay households
incomes for the services
of factors of production.
• Households pay firms for
the goods and services
they buy.
• These are the money flows.
• The blue flows are incomes.
• The red flows are
expenditures.

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