A circular flow diagram is an economic model which is built on some assumptions and they are:
The above video explains the circular flow diagram comprehensively
- There are only two participants in the market i.e. households and firms
- The market is not regulated
- There are no exports or imports
- The output is equal to the inputs
- As mentioned earlier that there are two participants in the market and they are households and firms.
- Households are the consumers and firms are the producers.
- Households consume goods but they supply factors of production namely land, labor and capital.
- Firms produce goods but they require factors of production
- The outer circle in the diagram represents the flow of inputs whereas the outer circle represents the flow of dollars
OUTER CIRCLE
- If we start from the top product markets supply goods to the households.
- The households consume the products and provide factors of production to resource markets
- These resource markets provide the resources to the firms and firms use the resources to produce goods and services
- Now we come to the inner circle
INNER CIRCLE
- Again we start from product markets. The revenue collected by the product markets is given to the firms
- The firms use this revenue to pay for the factors of production
- This payment is a source of income for households
- The households then spend their income in purchasing goods from the product markets.
The above video explains the circular flow diagram comprehensively