How do economists use circular flow models?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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Economists use circular flow models as a way to illustrate the way a market economy works and how the various parts of that type of economy are linked to one another.

The circular flow model is used to show how households and businesses are linked together.  It shows businesses buying from households in factor markets while households buy from businesses in product markets.  This emphasizes to us the way in which businesses and households depend on one another in a market economy.

Circular flow models, then, are used a simplified way of explaining how a market economy works.

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