Question

1. Illustrate (provide the graph) and discuss the distribution of incomes in the circular flow model

Answer 1

Please refer to the above diagram for the circular flow of income model. In this simple model, there are two agents, households and firms. Households own factors of production, whereas firms hire factors of production to produce goods and services, which in turn are consumed by households.

In the factor market, households supply their factor services to the firms, for which they get factor payments from the firms. These factor payments serve as income to households, which they shall spend on consumption.

In the product market, the goods and services produced by the firms using the factors of production are sold by them to households, who in turn make payments for this consumption of goods and services to firms. This serves as income for these firms and businesses, and they use these incomes to further hire factors of production to produce goods and services, and the cycle goes on.