Discuss the circular flow of goods and services in a free-enterprise economy.


Circular Flow

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Posted on (Answer #1)

In a free market economy, the participants of the economy can be divided into two broad categories, the consumers i.e. the households and the producers which are the businesses. When households buy from the businesses they pay them for the goods and services received. The amount received by the businesses is used to buy resources and to pay for the labor employed to produce what the businesses sell. The labor is provided to the businesses by people who are members of the households that buy from the producers. In many cases raw materials are also bought from people that form the consumers of the same businesses they sell their produce to.

As a result of this, money moves in a circle, from the households to the businesses and back to the households. If there is an increase in consumption by the households the demand for the goods and services produced by the businesses goes up and so does their expenditure in procuring raw material and paying labor. As businesses pay more wages households have a larger amount to spend on the produce of the businesses.

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