Note: From Principles of Economics, Circular-flow Diagram by N. Mankiw, 2024, Cengage.
The circular-flow diagram is a visual model that shows how money flows through the markets in an endless loop (Mankiw, 2024). The diagram above shows the relationship between households and firms through two types of markets.
How to Read a Circular Flow Diagram
Households purchase goods and services from firms and provide factors of production, such as labor, land, and capital, to firms.
Firms produce and sell goods and services and hire and use factors of production.
Firms are the sellers and households are the buyers in these markets.
Households supply factors of production, while firms purchase and use these resources in production.
Households and firms depend on one another. Households provide resources to firms and purchase their products, while firms use those resources to produce and sell goods and services.
Follow the Arrows:
Red arrows: Show the flow of resources, goods, and services.
Green arrows: Show the flow of money, including wages, rent, and spending on goods and services.
Mankiw, N. G. (2024). Principles of Economics. Cengage Learning.
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