Circular flow

• The circular flow model shows the relationship between households, firms, government, and other sectors.
• Circular flow diagram depicts the flow of money in the economy
• Households/Consumers (C):

  • Also known as consumers
  • Owners of the factors of production (Capital, entrepreneurship, labour, land)
  • Sells factors of production to businesses via the factor market
  • Taxes on income received from businesses are paid to the government
  • They buy goods and services via the product market
• Businesses/Firms (I):

  • Also known as firms
  • Produces goods and services sold via the product market
  • Businesses earn income from sales to households and government
  • Pays taxes to the state
• Government/State (G):

  • Also known as state
  • Uses taxes to provide goods and services to households and businesses
  • Participates in the economy through legislation and acting as a producer
• Foreign Sector:

  • Imports (Leakages)
  • Exports (Injections)
• Diagram of Closed Economy
• In a closed economy, there is a close interaction between households, businesses, and government

  • A closed economy has three participants and does not interact with the foreign sector
• Economics is a social science that studies how individuals, businesses, government, and societies allocate resources to satisfy their needs and wants
• Scarcity is the central problem of economics, existing due to the unlimited needs of humans and their limited resources, forcing choices between alternatives
• Absolute scarcity is the inability of nature to provide necessary resources to satisfy daily needs, like a drought limiting agriculture production leading to starvation
• Relative scarcity occurs when goods and services are available but consumers lack the resources to acquire them, like wanting to buy Levi jeans but not having enough money
• Opportunity cost is the value of the best alternative that could have been chosen but was not chosen, arising from scarcity and the need to make choices to satisfy needs
• Free goods are freely available in unlimited quantities like sea sand, while economic goods are available in limited quantities, command a price, and indicate wealth and prosperity when possessed and used
• Inflation is a general increase in prices, typically between 3-6%, with cost-push inflation caused by producers raising costs like petrol, and demand-pull inflation caused by consumers chasing limited goods