Question

Using the circular flow model, explain the flow of money and goods in an economy.

Answer 1

Following figure depicts the Circular Flow Model -

The circular flow model depicted above consists of two sectors - Households and Firms.

Households supply the factors of production to the firm and purchase goods and services from the firms.

On the other hand, firms purchase factors of production from households and sell goods and services to the houuseholds.

This circular flow depicts two types of flow - Real or goods flow and nominal or money flow.

Real flow indicates the purchase of factors of production by firms from households which are then utilized to produce goods which are then sold by the firms to the households.

Nominal flow indicates the factor payments made by the firms to households for purchase of factors of production and payments made by the households to the firms for the purchase of goods.

In this way, money and goods flow within an economy in circular manner.