The Circular Flow of Economy

The circular flow of income, or simply the circular flow, describes how a market economy works. A market economy is one in which individuals influence directly what is produced, marketed and consumed. Individuals do this by spending money on what they want. This then directs producers to produce goods and services that individuals will consume. The amount of goods and services that are made available is related to the laws of supply and demand.

Source: Encyclopedia of Business and Finance

The two main pieces that make up this model are business (producers) and households (consumers). Businesses purchase resources used to produce goods or services and sell them to the households. Households provide labor in exchange for income and with that money purchase the goods and services created by business.

The resource market includes the capital, enterpreneurs, land (natural resources) and labor (human resources) required by producers. The products market includes the goods and services required to satisfy the wants and needs of the consumers.