THE CIRCULAR FLOW
➢ The circular flow shows how an economy works in the real world.
“The economy of a country can be viewed as a system where goods,
services, factors of production and money change hands between many
participants.”
❖ A closed economy which excludes trade with other countries
❖ An open economy which includes trade with other countries (also called
foreign trade).
The participants in the circular flow of a closed economy.
THE PARTICIPANTS IN THE CIRCULAR FLOW OF A CLOSED ECONOMY
➢ The economy cannot function if a specific group of participants partake in the
function as well as the running of the economy.
➢ In a closed economy we look at four participants and what their role is in the
economy.
MARKETS
➢ The circular flow cannot circulate without a goods and services market also known
as the product market and a factor market.
➢ These two markets are like intermediaries for the four participants in the economy.
➢ A product market is basically a place where buyers and sellers exchange money
for goods, such as a supermarket.
➢ The prices of goods and services that consumers buy are determined in the
product market, and the prices for factors of production that businesses and the
government buy are determined in the factor market.
➢ Collectively, all supermarkets form part of the product market. If there is a shortage
of rice in the country the price of rice will increase because the supply cannot meet
the demand.
The labour market is one of the factor markets. This is where people look for
employment and businesses or government looks for labour by advertising vacant
positions.
FLOW OF GOODS AND SERVICES
➢ Goods and services, money, and the factors of production all form part of the
circular flow of a closed economy.
We will look at each of them in turn, gradually building up a complete picture
of the circular flow model.
➢ Goods and services are the things that we use in order to satisfy our needs and
wants.
➢ Businesses provide households with goods and services in exchange for
consumer expenditure.
The flow of Factors of Production
➢ The factors of production play a vital role as this is something the households
provide to the factor market who then in turn provides these factors to the
businesses and the government.
The flow of money
➢ In a closed economy the flow of goods and services as well as the factor factors of
production can only take place when there is a reward for it.
➢ In order for individual to purchase goods and services they need to have money to
do so, they get this money from the labour they offer to the factor market. When
businesses receive the money for the goods purchased, this is used to purchase
more stock and is a profit to the business.
Circular Flow (Real flows)
➢ Households and businesses are dependent on each other.
➢ Households need to buy goods and services from businesses and businesses
cannot operate without the factors of production supplied by households.
The circular flow (money flows)
➢ Whenever something is bought money is paid.
➢ The circulation of money is called the money flow. To complete the circular flow
diagram, we now need to add in all the money flows.
CIRCULAR FLOW MODEL
➢ The circular flow model describes the movement of money through the
economy between households, businesses and government.
➢ The money households earn by selling the factors of production to businesses
is spent on goods and services, which the businesses produce using the
households’ labour.
➢ Households need to carry on selling their labour to earn money to buy the
goods and services to meet their needs.
➢ Businesses also need to carry on selling their labour to earn money to buy
the goods and services to meet their needs.
➢ Businesses also need to carry on producing goods and services to sell to
households so that they can make money.
➢ These flows never stop, and because the flows all rely on each other, we say
that the movement of money, goods, services and factors of production through
the economy is circular.