Question

Describe the circular flow model. Who are the economic actors? Where and how do they interact? What does this model tell us about the macroeconomy?

Answer 1

There are innumerable producers and households in an economy. There is a continuous flow of economic activities like production, consumption, exchange and distribution. These activities generate income and expenditure which flows continuously among various sectors. These different sectors are inter-related and inter-dependent. An economic actor is a person or an unit which uses economic resources such as land, labour and capital. These economic actors utilizes the resources to generate income.

How and where these economic actors interact is given below:

I considered simple economic model which has two economic actors, they are 'households ' and 'firms ' .

The household sector supplies factors such as land, labour, capital and organisation to firms. And the firms produce and supply goods and services to households. This supply of goods and services from one sector to another sector is called real flow. Firms make factor payments such as rent, wages, interest and profit to households as reward for factor services. Households spend this income on buying goods and services produced by firms. This is money flow. This way, production, generates factor income, which is converted into expenditure. Thus, production is a continuous activity because human wants are unlimited. This makes the flow of income circular.

This model assume the followings regarding macroeconomy

1. There are only two sectors in economy. 2. Households are the owners of factors of production. 3. Households receive income by selling the factor services spend their entire income on consumption. So there are no savings. 4.firms sell their entire production. So no inventories.