Macroeconomics 203Macroeconomics 203The Circular Flow

Circular Flow ModelCircular Flow Model It is a model of the economy that

shows the circular flow of expenditures and incomes that result from decision maker’s choices and the way those choices interact to determine what ,how ,and for whom goods and services are produced.

HouseholdsHouseholds & & FirmsFirmsHouseholds are individuals or

groups of people living together.Households own the factors of

production-land ,labor ,capital ,and entrepreneurship-and choose the quantities of these resources to provide to the firms.

Households also choose the quantities of goods & services to buy.

Households & FirmsHouseholds & FirmsFirms are the institutions that

organize the production of goods & services.

Firms choose the quantities of the factors of production to hire and the quantities of goods & services to produce.

MarketsMarketsA market is any arrangement that

brings buyers and sellers together and enables them to do business with each other.

An example is the world oil market. It isn’t a place , but it is the network of oil producers, oil users , wholesalers, and brokers who buy and sell oil.

The decision makers do not meet physically.

They make deals by telephone , fax ,and the internet.

Goods MarketsGoods Markets & & Factor Factor MarketsMarketsGoods Markets :Markets in which

goods and services are bought and sold.

Factor Markets: Markets in which the services of factors of production are bought and sold.

Real Flows Real Flows & & Income Income FlowsFlows

In Factors Market:When households choose the quantities of

the services of land ,labor, capital ,and entrepreneurship to offer in factors market , they respond to the incomes they receive- rent for capital, wages for labor, interest for capital ,profits for entrepreneurship.

When firms choose the quantities of factor services to hire ,they respond to the rent ,wages, interest, and profits they must pay.

Real Flows Real Flows & & Money FlowsMoney FlowsIn Goods Markets: When firms choose the quantities of

goods & services to produce and offer for sale in goods market , they respond to the amount that they receive from the expenditure that households make.

When households choose the quantities of goods & services to buy, they respond to the amount they must pay to firms.

Real FlowsReal Flows They are :1.The flows of the factors of

production that go from households to firms.

2.The flows of goods & services that go from firms to households.

Money FlowsMoney FlowsThey are:1.The flow of payments made in

exchange for the services of factors of production (payments from firms to households).

2.The flows of expenditures on goods& services (expenditures from households to firms).

What ,How ,and For WhomWhat ,How ,and For WhomThe choices that generate these real and money flows determine what ,how ,and for whom goods and services are produced.

Government in the Circular Government in the Circular FlowFlow

Governments buy goods and services from the firms and make expenditures on them.

Households and firms pay taxes to the governments

Also governments make money payments to households and firms( the transfers).