Circular Flow Model

Circular Flow Model is the process by which money flows in the economy. The company pays money to the worker and those workers will pay back to the company in exchange for goods or service. The money flows from producer to household and will flow back again. It is the cycle flow of money that will go on forever. Both activities are very important to the economic flow. We go to work in exchange for money and we use the money to buy goods or services.

The government needs to analyze the circular flow as it has an impact on the country’s GDP (Gross Domestic Product). Moreover, the government may need to adjust the monetary and fiscal policy to improve the economy.

When households need goods or services in their daily life they need to purchase from the company. The company itself also needs to use goods to support daily operations, so they need to purchase from other producers as well. The producer needs to purchase raw material and labor from the community, so the money will flow back to them.

Factors not include in Circular Flow:

  • Government Spending: Government is one of the big producers and consumers in the economy but their spending and consumption are not included in the circular flow model. The government provides a thousand jobs to the government officers such as soldiers, teachers, and so on. Government also consume any kinds of goods to build the infrastructure and provide public service to the resident.
  • Government Tax: Tax is a tool which use by the government to take the money out of the economy. The government imposes a tax on both households and businesses in form of the different taxes such as sale tax, profit tax, property tax, and so on.
  • Foreign investors: Foreign investors inject goods into the market and export the goods from the economy. Instead of using money, they use goods to trade with the local producer and consumers.
  • Bank: Bank injects billions of dollar into the market which help to support the household and business. They inject money in form of loans, mortgages, and other types of liability.