Definition
Circular Flow of Economy is a model that illustrates the continuous movement of money, goods, services, and resources between households, businesses, and the government. It shows how income earned by households from selling labor and other resources is spent on goods and services, which generates revenue for businesses, creating a continuous economic cycle.
Why It Matters
Understanding the circular flow helps economists and policymakers see how different sectors interact, how income and spending sustain economic activity, and how disruptions in one part of the economy can affect others. It also provides a foundation for studying national income, fiscal policy, and economic equilibrium.
Example
Households provide labor to businesses in exchange for wages. They use these wages to buy goods and services from businesses, which in turn pay rent, wages, and profits back to households. Government collects taxes and spends on public goods, further circulating money through the economy. This flow ensures a continuous exchange of resources, goods, and money.