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GRAPHIC ORGANIZER
Economic Sectors
CHART
Circular Flow of Economic
Activity
GRAPH
Consumer Expenditures
VIDEO
Lesson 2
Economic Flow and
Economic Growth
ESSENTIAL QUESTION Why and how do people make economic choices?
It Matters Because
People of all ages and from every part of the country contribute to
the U.S. economy.
PHOTO: (tl) Ariel Skelley/Getty Images; (tc) Ross Harrison Koty/Getty Images; (tr) Digital Vision/PunchStock
NGSSS covered in
“The Circular Flow Model”
SS.7.E.2.1 Explain how federal, state, and
local taxes support the economy as a
function of the United States government.
LA.7.1.6.1 The student will use new
vocabulary that is introduced and taught
directly.
LA.7.1.7.3 The student will determine the
main idea or essential message in
grade-level or higher texts through
inferring, paraphrasing, summarizing, and
identifying relevant details.
Reading HELP DESK
Taking Notes: Identifying
As you read the lesson, complete a
diagram identifying the four sectors
of the economy. LA.7.1.7.3
The Circular Flow Model
GUIDING QUESTION Why do resources, goods, and services flow in a circular pattern in
a market system?
How can you understand what goes on in a country’s economy?
Economists like to use models to show how things work.
A model is a graph or diagram used to explain something.
Demand and supply curves are models. In this lesson we
will study another one, the circular flow model. This model
shows how resources, goods and services, and money flow
between businesses and consumers. The model has a circular
shape because the flows it shows have no beginning or end.
For example, you might have a job in a bookstore. You use the
income you earn to purchase a book. The bookstore uses that
money to pay your wages, and so on. As you can see, the money
flows in a circular pattern.
The circular flow model has four parts. Two parts are markets
where buying and selling take place. Two parts are sectors, or
categories, that stand for the two main groups of participants in
the markets. These are the people and businesses that are active in
the economy. We will start by looking at the two markets.
Economic Sectors
Content Vocabulary
• circular flow model • economic growth
• factor market
• productivity
• product market
• specialization
Lesson 2 487
The Factor and the Product Markets
The first market is the factor market. This is where factors
of production are bought and sold. When people go to work,
they sell their labor in the factor market. Capital resources
like machines and tools are also bought and sold in the factor
market, as are natural resources like oil and timber.
The product market is where goods and services are offered
for sale. You can think of this market as one big store where
all products and services are sold. All exchanges of goods and
services take place in the product market.
The Consumer Sector and Business Sector
Economists think of the buyers in the economy as being divided
into four groups called sectors. To keep the diagram simple,
the circular flow model shown here has only two sectors: the
consumer sector and the business sector. The two sectors not
shown are the government sector and the foreign sector. After
you have learned how the first two sectors operate, these other
sectors will be discussed.
Consumers take part in both the factor and the product
markets. When consumers go to work, they sell their labor in the
factor market. When they get paid, they take that money to the
product market, where they buy goods and services. To earn more
income, they return to the factor market and sell their labor again.
CHART SKILLS
This simple model of the circular
flow of economic activity shows
how the business and consumer
sectors interact in the factor
market and the product market.
CRITICAL THINKING
1 Analyzing Visuals What
happens in the product
market?
CIRCULAR FLOW OF ECONOMIC ACTIVITY
PRODUCT
MARKETS
$
$
Goods and
Services Purchased
Goods and
Services Sold
BUSINESS
SECTOR
CONSUMER
SECTOR
Labor, Land, Capital
and Entrepreneurship
Inputs for
Production
2 Explaining How do
consumers get the income
they need to buy products?
$
FACTOR
MARKETS
$
= Flow of dollars
= Flow of goods & services
Reading HELP DESK
Content Vocabulary (cont.)
• division of labor
• human capital
488 The American Economy
circular flow model a
model showing how goods, services,
and money flow among sectors and
markets in the American economy
Academic Vocabulary
sector a category, or a
part of a whole
factor market a market
where productive resources are
bought and sold
By doing their weekly grocery shopping,
this family is participating in the product
market. The average American family
spends more than 12 percent of its income
on food.
▲
PHOTO: Ariel Skelley/Getty Images
CRITICAL THINKING
Finding the Main Idea This family is acting
as what sector of the economy?
The business sector represents all the companies that
produce goods and services. This sector is also active in both
markets. Businesses sell goods and services in the product
market. They use the money they receive from these sales to buy
land, labor, and capital in the factor market.
The Circular Flow
If you look at the whole diagram, you can see that the loop
representing money always flows in the clockwise direction.
Starting with the consumer sector, money flows through the
product market to the business sector. Money then flows
through the factor market back to the consumer sector. The loop
representing goods, services, and factors of production flows in
the opposite direction.
The key feature of the model is to show that money flows
in one direction while the products and productive resources
flow in the opposite direction. This is precisely what happens in
real life. For example, suppose you purchase a bottle of water
from a vending machine. You put the money in, and the water
bottle comes out. The money and the product you buy flow in
opposite directions.
The circular flow model also shows something else. It shows
that markets link the consumer and business sectors. You
probably will never set foot in the factory that makes some of
your favorite products. However, you still interact with that
factory when you buy its products at the store.
product market a market
where goods and services are for
sale
Reading Strategy: Paraphrasing
Describe in your own words the circular flow of
economic activity. Use real-life examples of
each sector you describe. LA.7.1.7.3
Lesson 2 489
PHOTO: Ross Harrison Koty/Getty Images
The government is a big spender. This
single military fighter costs more than
$15 million.
The Government and Foreign Sectors
▲
CRITICAL THINKING
Making Connections How does the
factor market connect the consumer
sector and the government sector?
Florida
CONNECTION
Government Spending
Florida has a gross domestic
product (GDP) of $737 billion.
State government spending
accounts for nearly 13 percent of
Florida’s GDP. The largest portion
of Florida’s spending goes to
education (26 percent), followed
by health care (18 percent).
Reading HELP DESK
Academic Vocabulary
comprise to be made up of
490 The American Economy
The simplified circular flow model does not show the
government and foreign sectors. Both of these sectors are
important, but adding them to the model would make it more
difficult to understand.
The government sector is comprised, or made up, of units of
the federal, state, and local governments. These units go to the
product market to buy goods and services, just as people in the
consumer sector do. Sometimes the government sells goods and
services to earn income. For example, state universities charge
tuition. Such charges are not enough to fund the government,
though. Instead, governments use taxes and borrowing to get
the money they need to operate.
The foreign sector is made up of all the people and
businesses in other countries. They act in both U.S. markets.
Businesses in other countries buy raw materials in U.S. factor
markets. They also sell their goods and services to consumers in
U.S. product markets.
In recent years, about 15 percent of the goods and services
we in the United States buy have come from foreign countries.
Also, about 13 percent of the things we produce are sold outside
the United States.
PROGRESS CHECK
Applying Where and how have you participated in the product market?
economic growth the
increase in a country’s total output
of goods and services over time
productivity the degree to which
resources are being used efficiently to
produce goods and services
Promoting Economic Growth
NGSSS covered in
“Promoting Economic Growth”
GUIDING QUESTION How can nations create and promote economic growth?
SS.7.E.1.3 Review the concepts of supply and
demand, choice, scarcity, and opportunity
cost as they relate to the development of
the mixed market economy in the United
States.
SS.7.E.3.4 Compare and contrast the
standard of living in various countries today
to that of the United States using gross
domestic product (GDP) per capita as an
indicator.
The United States has experienced a clear upward trend
in GDP over the past 50 years. This reflects our nation’s
steady economic growth. Economic growth is the increase
in a country’s total output of goods and services over time.
Whenever GDP goes up from one year to the next, it means the
economy has grown. Government and business leaders work
hard to promote economic growth. Why? Because when the
economy grows, the nation’s wealth increases. This also helps
improve the standard of living.
Two things are needed for economic growth. The first is
additional resources. The second is increased productivity.
Additional Productive Resources
PHOTO: Digital Vision/PunchStock
Increasing Productivity
Productivity is a measure of how efficiently
resources are used to create products.
Productivity goes up when more products
are made with the same amount of factors
of production in the same amount of time.
Productivity goes down if fewer products
are created using the same amount of the
factors of production or more time. Suppose
a factory that has made 1,000 computers each
week begins to make 1,100 a week with the
same number of workers. In that case, its
productivity has increased.
The automobile assembly line is a good
example of the division of labor. Each
worker stays in one place and performs
a single task to assemble, or put to
together, a car. The car is assembled piece
by piece as it moves down the line. The
use of the assembly line in manufacturing
led to a rise in productivity and a
reduction in costs.
▲
As you know, the four factors of production are used to make
goods and provide services. If a country were to run out of these
factors, increasing production would be much more difficult
and perhaps impossible. This would cause economic growth to
slow or even to stop.
One key resource, land, is in limited supply. Only so much
oil is under the ground, and it may run out someday. There
is only so much timber to be cut, so it is important to plant
new trees regularly. Also, our country has a limited amount of
freshwater, so it is important to use it wisely and keep it clean.
When we work to save or preserve our trees, fields, streams,
and other natural resources, we are helping lay a foundation for
future economic growth.
Economic growth also needs a growing
population or one that is becoming more
productive. This takes us to the next
requirement for growth—productivity.
CRITICAL THINKING
Drawing Conclusions How do you think
the use of assembly lines in manufacturing
affected the country’s economic growth?
21st Century
SKILLS
Write a Research Report
Automaker Henry Ford pioneered
the use of assembly lines in
automobile manufacturing in
1913. Research the ways in which
the assembly line changed how
Americans made and bought cars.
In your report, include details on
how these changes affected
autoworkers.
specialization when people,
businesses, regions, and/or nations
concentrate on goods and services
that they can produce better than
anyone else
division of labor the
breaking down of a job into separate,
smaller tasks to be performed
individually
human capital the sum of
people’s knowledge and skills that
can be used to create products
Over the years, there have been two key changes in how
products are made. These are specialization and the division
of labor. Both improve productivity. Specialization occurs
when people, businesses, regions, or countries concentrate on
goods or services that they can produce more efficiently than
anyone else. For example, a region that has a mild climate and
fertile land will specialize in farming. A person who has good
mechanical skills might specialize in car repair. By specializing,
each becomes more efficient—or productive.
Specialization by people leads to another development
that increases productivity: division of labor. Division of labor
means breaking down a job into separate, smaller tasks that are
done by different workers. This improves productivity—which
increases economic growth.
Businesses always strive to be more productive because their
goal is to make more money. They may increase productivity in
different ways. One way is to improve production methods. For
example, a factory might invent a new process that results in
less waste of a costly resource. Businesses can also use new and
better information technology. Computers, for example, let one
person do work that was once performed by several people.
Production can also be improved by using higher-quality
factors of production. This is especially true of one factor of
production: labor. When economists talk about the quality of
labor, they use the term human capital. Human capital refers to
the knowledge, skills, and experience that workers can draw on
to create products. How can we improve human capital? Three
key factors are education, training, and experience. As workers
gain more of these, the quality of their work improves and they
become more productive. As you know, greater productivity
leads to economic growth and a higher standard of living.
PROGRESS CHECK
Synthesizing How do people benefit from economic growth?
LESSON 2 REVIEW
Review Vocabulary
1. What is the difference between a factor market and
a product market? LA.7.1.6.1
2. What do the terms specialization and division of
labor mean? How is each related to productivity?
LA.7.1.6.1
Answer the Guiding Questions
3. Identifying What roles does government play in
the circular flow model? SS.7.E.2.1
492 The American Economy
4. Analyzing How do you think specialization is
related to differences in GDP between one country
and another? SS.7.E.3.4
5. EXPOSITORY WRITING Suppose you
manufactured a product that required a scarce
natural resource that was rising in cost. Describe
how increased productivity might help you avoid
passing on rising costs to your consumers in the
form of higher prices. SS.7.E.1.3