1. Circular Flow Model of a Market Economy
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2. Terminology
circular flow model households business firms Factor/Resource Market Product Market Source: AmosWEB Encyclonomic
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3. Circular Flow Model
Model used to show the interdependent relationship of buyers and sellers within a market.

4. 2 Sector (Part) Circular Flow Model
Our two sectors are :
1. Households
2. Business Firms
Our two markets are:
1. Factor/Resource Market
2. Product Market
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5. Two Sectors
Households
Businesses

6. Households
The household sector includes the entire population of society.
It includes all of the consumption-seeking members of society--the entire population.
It IS society. In effect, the economy exists to satisfy the wants and needs of the household sector.

7. Households No House Needed
While this sector goes by the name "household," members are not required to own a house, to live in a house, or to have ever seen a house. The term household sector is merely a short-cut used to indicate the consuming, wants-and-needs-satisfying population of society, most of who actually do live in houses.

8. Households
For example:
Pollyanna Pumpernickel, who lives in a rented two-room apartment, is a member of the household sector.
Winston Smythe Kennsington III, who owns several residences, including an extremely large mansion, a penthouse apartment, and a yacht docked in the harbor, is a member of the household sector.

9. Households
Alton Hogkins, who spends his nights sleeping in a cardboard box under a bridge, is a member of the household sector.
Even Duncan Thurly, who owns an actual house in the suburbs, is part of the household sector.

10. Households
The household sector owns the factors of production—land, labor, and capital.
It sells the services of these resources to the business sector in exchange for income.

11. Households
For example, a pleasant mother of two, Pollyanna Pumpernickel, is a member of the Shady Valley household sector who own labor resources. Pollyanna sells her labor services as a part-time pet store clerk at Perry Paxton's Pet Palace. Labor is the extent of the Pollyanna's productive resources.

12. Households
Winston Smythe Kennsington III, the President, Chief Executive Officer, and Chairman of the Board of Directors of OmniConglomerate, Inc., is also a member of the Shady Valley household sector. Winston also receives income from providing productive labor resources as President of OmniConglomerate. In addition, Winston provides his entrepreneurship as the BIG guy who takes the BIG risks and makes the BIG decisions for OmniConglomerate. Moreover, Winston owns OmniConglomerate stock, which means that he owns part of OmniConglomerate's capital and land resources.

13. Households
While the household sector is designated based on WHO is included--households, people--this sector can also be defined based on WHAT it does--which is consumption.

14. Households
Pollyanna Pumpernickel uses her income for consumption expenditures on food, clothing, shelter, entertainment, and other wants-and-needs satisfying goods and services. Pollyanna pays the rent, puts food on the table, and treats her girls to an occasional Hot Momma Fudge Bananarama Ice Cream Sundae. The Pumpernickels also consume goods that require no expenditure, such as "quality" family time.

15. Households
While Winston Smythe's bank account is substantially bigger than Pollyanna's, he also uses his income for consumption expenditures food, clothing, shelter, entertainment, and other wants-and-needs satisfying goods and services. While the quality, expense, and volume of Winston's consumption expenditures might differ from those of the Pollyanna's, the underlying process is the same. Rather than tacos, T-shirts, and 2-room apartments, Winston tends to purchase Filet Mignon, designer suits, and 100-room mansions. And of course, Winston is also inclined to consume expenditure-free goods, such as strolling through a nearby park.

16. Resource Market Households Businesses
Resources = Land, Labor, Capital, Entrepreneurship
Resource Market
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17. Business Firms
Business Firms – an organization that uses resources to produce a product, which it then sells.
Firms transform “inputs” or factors of production, into “outputs” or products.

18. Business Firms
This sector contains the private, profit-seeking firms in the economy that combine scarce resources into the production of wants-and-needs satisfying goods and services. It includes proprietorships, partnerships, and corporations.

19. Business Firms Firms purchase or rent land.
They hire workers, paying them wages or salaries for their labor.
They also borrow money from households to purchase capital, paying households interest or profits in return.
This makes up what we call national income.
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20. Resource Market Households Businesses
$$ Nat’l Income = Rent, Wages, Interest, Profit $$
Resources = Land, Labor, Capital, Entrepreneurship
Resource Market

21. Factor/Resource Market
A factor or resource market, where the factors of production are bought/sold

22. Factor/Resource Market
Factor markets, also termed resource markets, exchange the services of factors, NOT the factors themselves.
For example, the labor services of workers are exchanged through factor markets NOT the actual workers.

23. Factor/Resource Market
Buying and selling the actual workers is not only slavery (which is illegal) it's also the type of exchange that would take place through product markets, not factor markets.

24. Factor/Resource Market
The services of these resources, however, are exchanged through factor markets. The value of the services exchanged through factor markets each year is measured as national income.

25. Factor/Resource Market
This exchange of resources for income payments takes place in what we call the factor or resource market. Households are the sellers and business firms are the buyers.
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26. Product Market
Market in which households purchase the goods and services that firms produce
Business firms are sellers…households are buyers

27. Business firms role in the Product Market
Business firms take the resources and turn them into products.
A product can be a good or a service.
They then sell the products to the households.
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28. Product Market Products =Goods & Services Households Businesses
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29. Households
Households use the income they earned from selling resources to purchase these products. This is called consumer expenditures.
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30. Product Market Products =Goods & Services $$$ Consumer Expenditures $$
Households
Businesses
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31. Product Market Resource Market Products=Goods & Services
$$ Consumer Expenditures $$
Households
Businesses
Nat’l Income = Rent, Wages, Interest, Profit
Resources = Land, Labor, Capital, Entrepreneurship
Resource Market
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32. How do government actions affect the CFM and how is the CFM affected by the rest of the world?
(consumption)
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