Overview
This lecture explains the circular flow model in economics, showing how products, resources, and money move among households, businesses, and the government in a market economy.
The Circular Flow Model
- The circular flow model illustrates the movement of products, resources, and money in an economy.
- Households (people) and businesses are the main participants in a market economy.
- Businesses sell goods and services to households in the product market (any place goods are bought, like stores or online).
- Households provide resources (land, labor, capital, entrepreneurship) to businesses in the resource market.
Factors of Production & Factor Payments
- The four factors of production are: land, labor, capital (tools, machines), and entrepreneurship.
- Households own these resources and sell them to businesses.
- Businesses use resources to produce goods and services.
- Factor payments are the incomes earned from resources: rent (land), wages (labor), interest (capital), and profit (entrepreneurship).
Money Flow in the Matrix
- Households buy goods and services, called consumer spending.
- Money paid by households becomes business revenue.
- Businesses pay for resources (cost of production), which provides household income.
Roles of Households and Businesses
- In the resource market: businesses demand resources, households supply them.
- In the product market: businesses supply products, households demand them.
- Both businesses and households are involved in both supplying and demanding.
The Role of Government
- The government buys goods/services from businesses and pays for resources (government spending).
- It provides public goods and services (roads, schools, fire protection) to households and businesses.
- The government gives out subsidies (to businesses) and welfare (to households); these are called transfer payments.
- Government spending is funded by taxes on businesses and households.
Additional Sectors (Mentioned but Not Detailed)
- The financial sector involves saving and lending money.
- Foreign sector includes imports and exports with other countries.
Key Terms & Definitions
- Circular flow model — a diagram showing how products, resources, and money move in an economy.
- Product market — where goods and services are bought and sold.
- Resource market — where resources (land, labor, capital, entrepreneurship) are bought and sold.
- Factors of production — resources needed to produce goods/services: land, labor, capital, entrepreneurship.
- Factor payments — income received for providing resources: rent, wages, interest, profit.
- Government spending — purchases of goods/services and resources by the government.
- Transfer payments — government payments to households/businesses not for goods/services (e.g., welfare, subsidies).
Action Items / Next Steps
- Review the circular flow diagram in your textbook.
- Prepare examples of product and resource markets for class discussion.