The Circular Flow Model is an economic model that describes how money, goods, and services move between different sectors in an economic system. The model is also known as the Circular Flow of Income because the flows of money between the sectors are tracked to measure a country’s national income or GDP. The idea of circular flow was first introduced by economist Richard Cantillon in the 18th century and then progressively developed by Quesnay, Marx, Keynes, and many other economists .
The basic circular flow model consists of two sectors: households and businesses. In this model, money flows from households to businesses as consumer expenditures in exchange for goods and services produced by the businesses. Then, the money flows back from businesses to households for the labor that individuals provide. This is the most basic circular flow model of an economy .
In reality, there are more parties participating in a more complex structure of circular flows. The five-sector model consists of households (the public sector), businesses, government, the foreign sector, and the financial sector. In this model, money flows from households to businesses as consumer expenditures in exchange for goods and services produced by the businesses. Then, the money flows back from businesses to households for the labor that individuals provide. The government collects taxes from households and businesses and pays back in the form of government expenditures through subsidies, benefit programs, public services, etc. The foreign sector represents the trade of goods and services between countries. The financial sector includes banks and other financial institutions that facilitate the flow of money between households, businesses, and the government .
The circular flow model is used to understand how money and economic resources flow in cycles between different sectors in an economic system. It is also used to measure a country’s national income or GDP. The model is a fundamental concept in macroeconomics and is used to explain how an economy runs. The model is also used to analyze the impact of changes in one sector on the other sectors of the economy .