PowerPoint Presentation

Circular Flow Diagram

Macroeconomics

Our First Model: The Circular-Flow Diagram

•The circular-flow diagram is a visual model of the economy that shows howdollars flow through markets among households and firms.

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The Circular-Flow Diagram

•Firms

• Produce and sell goods and services

• Hire and use factors of production

•Households

• Buy and consume goods and services

• Own and sell factors of production

The Circular-Flow Diagram

•Markets for Goods and Services

• Firms sell

• Households buy

•Markets for Factors of Production

• Households sell

• Firms buy

The Circular-Flow Diagram

•Factors of Production

• Inputs used to produce goods and services

• Land, labor, and capital

Figure 1 The Circular Flow

Spending

Goods and

services

bought

Revenue

Goods

and services

sold

Labor, land,

and capital

Income

= Flow of inputs

and outputs

= Flow of dollars

Factors of

production

Wages, rent,

and profit

FIRMS

•Produce and sell

goods and services

•Hire and use factors

of production

•Buy and consume

goods and services

•Own and sell factors

of production

HOUSEHOLDS

•Households sell

•Firms buy

MARKETS

FOR

FACTORS OF PRODUCTION

•Firms sell

•Households buy

MARKETS

FOR

GOODS AND SERVICES