Circular Flow of Income Model
What Is Economics? Scarcity, Choice, and Economic Models
Syllabus requirement
Models the interdependence among households, firms, government, the financial sector, and the foreign sector.
Summary
The circular flow of income model is a macroeconomic tool that shows how households, firms, the government and the foreign sector interact through factor and product markets to determine national income. The model traces flows of income (payments for factors of production) and spending, and it highlights leakages (taxes, savings, imports) and injections (government spending, investment, exports) that alter aggregate activity. Closed and open versions of the model distinguish economies with and without a foreign sector. The model helps explain interdependence among economic agents and the equality of total income, expenditure and output in equilibrium.
