Definition
Circular Flow is a model of the economy that illustrates how money, goods, services, and resources continuously move between households and businesses. Households provide labor and capital to businesses, while businesses supply goods and services in exchange for revenue that flows back to households as income.
Why It Matters
Understanding the circular flow helps explain the interdependence of different economic actors and sectors. It highlights how spending and production drive the economy and how disruptions in one part, such as lower household spending or reduced business investment, can affect the entire system.
Example
Households earn wages by providing labor to firms. They use this income to purchase goods and services from those firms. The revenue firms earn allows them to pay wages, invest in production, and produce more goods, completing the circular flow of money and resources.