However, this is at least partially offset by exports, which leak goods but injects income. Through imports, the foreign sector injects goods but leaks income because goods are manufactured offshore. They can also inject money into the circular flow model in the form of loans and interest rate cuts. Financial institutionsīanks also contribute to leakage by encouraging households and businesses to save their money with higher interest rates.
Governments also remove money from the flow (“leakage”) through sales, income, or property taxes. Government spending can be directed toward the product market (a new highway) and the resource market (teachers, fuel, or electricity).
#FREE MARKET CIRCULAR FLOW DIAGRAM DRIVERS#
Indeed, simplistic circular flow models omit other key drivers of economic systems.Īn important player because of its ability to inject and remove money from the flow. Supply and demand rarely occur in a vacuum. Other key factors in the circular flow model This income is then used by the household to purchase goods and services, thereby restarting the process.
With resources acquired, the business must pay workers and landowners to create goods and services in the form of income. To manufacture or provide goods and services for the product market, the business must purchase resources from the resource market. The product market then purchases goods and services from businesses to provide them to households. Most understand this process as consumer spending. When a household wants to purchase a good or service, money flows toward the product market. In this case, money flows in the opposite direction to that of goods and services and production factors. Land receives rent and real capital receives a rate of return.įirms also inject money into the circular flow model through production function.Ī simple production function ( Q) formula argues that output is a function ( f) of factor inputs, where Q = f (L, La, K).Ĭonsumer spending in the circular flow modelĪnother way to think of the circular flow model is by considering income and spending. Transactions are attributed to factor incomes.įor example, human capital receives a wage in exchange for labor. Money moves between households and firms in a cyclical process whenever a transaction takes place. This is achieved by paying for the services of the abovementioned factors. Whose primary function is to supply goods and services to households and other firms. The 4 factors of production are land, enterprise, real capital, and human capital and each is supplied by factor owners in exchange for a reward.įor example, land is supplied by landowners, human capital is supplied by labor, and capital is supplied by capital owners.Įntrepreneurs, who absorb enterprise production risks, combine land, human capital, and real capital. Whose primary function is to supply firms with production factors. Understanding the circular flow model Households Other key factors in the circular flow model. Consumer spending in the circular flow model. Digital Business Models Podcast by FourWeekMBA. Business Strategy Book Bundle By FourWeekMBA. 
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