Download In economics, a circular flow model is a diagram that is

In economics, a circular flow model is a diagram that is used to
represent the monetary transactions in an economy.
LEARNING OBJECTIVE [ edit ]
State the function of the circular flow diagram and the production possibilities frontier
KEY POINTS [ edit ]
There are two flows present within the model including flows of physical things (goods or labor)
and flows of money (what pays for physical things).
The circular flow of income follows a specific pattern: Production → Income → Expenditure →
Production.
The production possibility frontier can be used to illustrate the circular flow model.
Economists use data, statistics, and natural experiments in order to make economic "laws" that
explain general patterns.
TERMS [ edit ]
Factors of production
In economics, factors of production are inputs. They may also refer specifically to the primary
factors, which are stocks including land, labor, and capital goods applied to production. expenditure
Act of expending or paying out.
Give us feedback on this content: FULL TEXT [edit ]
In economics, a circular flow model is a diagram that is used to represent the monetary
transactions in an economy. There are two flows present within the model including flows of
physical things (goods or labor) and flows of money (what pays for physical things). A
circular flow model depicts the inner
workings of a market system and specific
portions of the economy.
The basic circular flow model consists of
two sectors that determine income,
expenditure, and output. A state
ofequilibrium is reached when there is no
tendency for the levels of income (Y),
expenditure (E), and output (O) to change
(Y=E=O). This equation means that the
Register for FREE to stop seeing ads
expenditure of buyers (households)
becomes income for sellers (firms). The firms spend the income on factors of production,
which "transfers" the income to the factor owners. The factor owners spend the income on
goods which leads to the circular flow of payments .
Circular flow of goods income
The circular flow model shows the flow of payments between households and firms.
The circular flow of payments is important within an economy because it 1) measures
the national income, 2) provides knowledge of interdependence, 3) illustrates the unending
nature of economic activities, and 4) shows injections and leakages.
The circular flow of income follows a specific pattern: Production → Income → Expenditure
→ Production. This circular flow is ongoing between households and firms.
The circular flow of income can also be analyzed using the production possibility frontier
(PPF). The PPF is a graph that shows the various combinations of amounts of
two commoditiesthat could be produced using the same fixed total amount of each of the
factors of production. The graph shows the maximum possible production level of one
commodity for any production level of the other, based on the state of technology . The PPF
defines production efficiency. A point of the frontier line indicates the efficient use of
available inputs, while a point beneath the curve shows inefficiency. A PPF graphs shows
opportunity cost, actual output, potential output, and economic growth.
Quantity of Guns Produced
B
X
D
A
C
Quantity of Butter Produced
Production Possibilities Frontier Curve
The graph illustrates a typical production possibilities frontier curve. When a market is operating on the
PPF it is said to be efficient.