What are the flows in the circular flow model?

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pohnpei397 eNotes educator| Certified Educator

In the most commonly used version of the circular flow model, there are two flows.  One is the flow of factors and the other is the flow of goods and services.  These flows combine in a circle, showing how the economy is a continuous loop of buying and selling.  This demonstrates for us the way in which households and firms are interconnected in our economy.

In one flow, households sell factors to firms.  The factor that fits this model most closely is labor.  People sell their labor to companies in exchange for money.  We see this every day as people go to work.  In the other flow, firms sell goods and services to households.  When people go to work for firms, they spend their time creating goods and services.  Those goods and services are sold to people from other households.  Thus, there is a circular flow that makes up our economic system, with firms buying factors from households and using those factors to create goods and services that they then sell to households.

Of course, the real economy is much more complex.  However, this simplified model allows us to understand the ways in which firms and households rely on one another to keep an economy going.