Circular Flow in a Market Economy

Where does your money go?

Map your dollarImagine you stop at your favorite fast food restaurant after school today and buy one item off the dollar menu. Where are all the places your dollar goes after it leaves your pocket?

Market: a place where buyers and sellers meet to engage in mutually beneficial exchanges with one another.

There are two types of markets in a Market Economy: The Product Market and the Resource Market.

There are two main players in a Market Economy: The Households(Consumers) and the Firms (Businesses)

The Exchange of Products and Resources

Households

Have 3 scarce resources:

Land: Natural Resources

Labor: Human Resources = workers

Capital: Anything used to make another product. Capital from households also includes money.

Firms

Established by entrepreneurs: people from households who start their own businesses.

Need resources from the households to make goods and services to sell back to the households.

Resource Markets Households sell, Firms buy: factors of production (land, labor and capital).

Money for land= Rent

Money for labor= Income

Money for capital= Interest

Money is the incentive for households to participate in the resource market. It allows them to receive goods and services in the product market.

Money

Resources

Product Markets

Firms sell, Households buy: goods and services

Firms produce goods and services to sell with factors of production purchased from households.

Households pay for goods and services with money acquired in Resource market (income)

Goods/Services

Money

The Circular Flow Model

Goals

Firms Maximize profits (total revenue

is greater than total cost)

Sell goods and services for more than they spent on resources

Households Maximize utility (happiness)

Happiness is achieved through the consumption of goods and services

The Government in the Circular Flow Model

Since a pure free market has never existed the government also falls into the circular flow model.

The government purchases goods and services from firms, and factors of production from households

The government collects money from both households and firms in the form of taxes

The government also provides goods and services to firms and households: roads, social programs, subsidies (financial aid to businesses or individuals) etc.

Taxes

Purchases

Factors

Expenditures

Mixed Economy Circular Flow Model

How do YOU Fit Into the Circular Flow

List all expenditures and activities you did this weekend that required spending money (could be spent by you or someone else)

Create a circular flow chart showing how your activities fit into the flow.