2.5 The Circular Flow Model

What does the circular flow model show?

Continuous flows of goods/services, resources, and money between households and businesses in product and resource markets.

Who are the two main decision makers in the circular flow model?

Households and businesses.

What are the two markets in the circular flow model?

The product market and the resource market.

What happens in the product market?

Businesses sell goods/services; households buy them.

What happens in the resource market?

Households sell resources; businesses buy resources.

What are the four resources households sell?

Land, labor, capital, and entrepreneurial ability.

What do households receive for selling resources?

Income: wages, rent, interest, and profit.

What do businesses receive in the product market?

Revenue from selling goods and services.

What do businesses pay in the resource market?

Costs: wages, rent, interest, and profit to households.

In the circular flow, what flows counterclockwise?

Real flows: resources → businesses; goods/services → households.

In the circular flow, what flows clockwise?

Money: income → households; spending → businesses.

In the resource market, who is the seller and who is the buyer?

Households sell resources; businesses buy resources

In the product market, who is the seller and who is the buyer?

Businesses sell goods/services; households buy goods/services

Why do all income flows ultimately go to households?

Because households own all resources: land, labor, capital, and entrepreneurial ability.

What do businesses do with the resources they buy?

Use them to produce goods and services.

What do households do with the income they earn?

Spend it in the product market on goods and services.

What does the circular flow model reveal about households and businesses?

Both are buyers and sellers: households sell resources and buy products; businesses buy resources and sell products.

What does Quick Review 2.4 say about competition?

It leads individuals and firms to promote the social interest, as if guided by an “invisible hand.”

Why do command systems fail?

They cannot solve the coordination and incentive problems.

What does the circular flow model illustrate overall?

How resources flow from households to businesses and how payments flow back from businesses to households.

In the circular flow model, the market economy creates ____

continuous flows of goods and services, resources, and money

In the circular flow model…

households spend their income in the product market

Which of the following occur in the resource market?

Businesses buy resources from households because they are necessary for producing goods and services.

Households provide economic resources directly as workers or entrepreneurs.

Households sell resources and businesses buy them.

Which of the following are found in the product market?

Goods + services