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Circular flow of income

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Model of the circular flow of income and expenditure

The circular flow of income is a model of the economy in which the major exchanges are represented as flows of money, goods and services, etc. between economic agents. The circular flow analysis is the basis of national accounts and hence of macroeconomics. This model can be depicted in a circular-flow diagram.


CONTENT : A - F , G - L , M - R , S - Z , See also , External links

Quotes

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Quotes are arranged alphabetically by author

A - F

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  • The circular flow diagram occurs in virtually all modern introductory economics textbooks as a way of explaining flows of income between firms and households and their measurement in the national accounts.
    • Mark Blaug, ‎P. J. Lloyd (2010). Famous Figures and Diagrams in Economics. p. 221
  • If the society toward which we are developing is not to be a nightmare of exhaustion, we must use the interlude of the present era to develop a new technology which is based on a circular flow of materials such that the only sources of man's provisions will be his own waste products.
  • Knight is the first to use the circular- flow diagram as a means of explaining the way in which the interaction of individuals and businesses in goods and factor markets simultaneously solve all the functions required for effective social organization (Knight 1951, pp. 61–6). Prices provide a measure of the social importance of goods and services (albeit ‘not a true index of social importance according to any recognized ethical standard’), ensure that productive resources are allocated to the production of goods and services which place the highest value on them, and simultaneously distribute income across the productive resources accordingly. ‘The principal connection between the price system and social progress’, meanwhile, ‘is mediated by the phenomenon of interest on capital’ (pp. 63–5).
  • Knight’s wheel of wealth emphasizes the circular flow of income in the economy as money is exchanged for factor services and final goods at successive stages in the production process. His emphasis on equalization of returns at the margin implicitly made his model an equilibrium one. And Knight’s approach contrasts with Carl Menger’s emphasis on the demand for final goods determining the prices of factors of production. Knight stressed instead the importance of opportunity cost, a characteristic feature of both Chicago economics and the Virginia School of Political Economy.
Circuit flow of money by Foster, 1922
  • The daily expenditures by consumers for new consumers' goods, upon which business stability largely depends, are determined in part by the total volume of money in circulation, in part by other factors including the frequency with which that money is returned to consumers. The flow of money, therefore, from use in consumption to another use in consumption should not be overlooked in studies of the causes and conditions of business fluctuations. It is the purpose of this paper to describe certain aspects of this circuit flow of money, to raise the question whether it does not deserve more attention that it has yet received in our analyses of business cycles, and to suggest pertinent lines of investigation. Unfortunately, the statistics upon which the most important conclusions concerning this subject must be based are not at hand and are not likely to be for a long time to come. The following discussion will have served its purpose if it stimulates further inquiry in profitable directions and helps to hasten the day when the necessary statistics are available.

G - L

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  • The circular-flow diagram is a visual model of the economy. The circular flow of income is coordinated by four key markets. First, the resource market (bottom loop) coordinates businesses demanding resources and households supplying them in exchange for income. Second, the loanable funds market (lower center) brings the net saving of households plus the net inflow of foreign capital into balance with the borrowing by businesses and governments.
    • James Gwartney, ‎Richard Stroup, ‎Russell Sobel (2010). Macroeconomics: Private and Public Choice. p. 191
  • [We may view the] economic organization as a system of prize relations. Seen in the large, free enterprise is an organization of production and distribution in which individuals or family units get their real income, their "living," by selling productive power for money to "business units" or "enterprises", and buying with the money income thus obtained the direct goods and services which they consume. This view, it will be remembered, ignores for the sake of simplicity the fact that an appreciable fraction of the productive power in use at any time is not really employed in satisfying current wants but to make provision for increased want-satisfaction in the future; it treats society as it would be, or would tend to become, with progress absent, or in a “static” state.
  • Fiscal, monetary, and growth policies are used by the government to maintain a healthy economy. We will look at their interaction and effects on the economy in two ways. The first is to use the circular flow diagram with government and the international sectors added. Another is to look at how these policies affect aggregate demand and aggregate supply.
    • George E. Kroon (2006). Macroeconomics the Easy Way. p. 69

M - R

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  • The circular-flow diagram offers a simple way of organizing the economic transactions that occur between households and firms in the economy. The two loops of the circular-flow diagram are distinct but related. The inner loop represents the flows of inputs and outputs. The households sell the use of their labor, land, and capital to the firms in the markets for the factors of production. The firms then use these factors to produce goods and services, which in turn are sold to households in the markets for goods...
  • In this model (circular-flow diagram), the economy is simplified to include only two types of decision makers—firms and households. Firms produce goods and services using inputs, such as labor, land, and capital (buildings and machines). These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce.
  • The circular-flow diagram a visual model of the economy that shows how dollars flow through markets among households and firms change much. We may even make the extreme and artificial assumption that all prices are completely fixed.
  • The circular flow diagram separates the economy into the business sector and household sector. The business sector supplies products and demands resources used in the production process. The household sector demands products and supplies resources used in the production process.
    • John Marthinsen (2014). Managing in a Global Economy: Demystifying International Macroeconomics. p. 18

S - Z

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The competitive price system adapted from Samuelson, 1961
  • The competitive price system uses supply-demand markets to solve the trio of economic problems — What How, and For Whom All demand relations are shown in blue. all the supply relations, in black.
  • How do we measure the net national product, NNP? The general idea is simple. Figure 10-1 shows the circular flow of dollar spending in an economy with no government and no accumulation of capital or net saving going on.
  • Figure 12-6 pulls together in a simplified way the main elements of income determination. Without saving and investment, there would be a circular flow of income between business and the public: above, business pays out wages, interest, rents, and profits to the public in return for the services of labor and property; and below, the public pays consumption dollars to business in return for goods and services.
    Realistically, we must recognize that the public will wish to save some of its income, as shown at the spigot Z. Hence, businesses cannot expect their consumption sales to be as large as the total of wages, interest, rents, and profits.

See also

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