Question

1.      Circular Flow Model: Explain and apply the simplified circular flow model used in economics.

Answer 1

Assumptions:

1. Domestic economy comprises only 2 sectors i.e. the producers and the households.

2. The households spend their entire income, so that there are no savings.

3. The domestic economy is a closed economy, so that there are no exports and imports.

4. There is no government in the domestic economy.

Real flow refers to the flow of goods and services across different sectors of the economy.

Money flow refers to the flow of money across different sectors of the economy.

Household sector pays money to producer sector as consumers consume goods and services in exchange of money. Producer sector also paying money to household sector for factor services like land, labor, capital and entrepreneurship.

Household sector receives money from producer sector for their factor payments like rent, wages, interest, profit.