The Circular flow of goods and incomes

The process of satisfying human wants involves producers and consumers. The relationship between it is two-sided, the consumer of goods and services are labelled ‘house holds’. Some members of households, of course, are also workers, and in some cases are the owners of other factors of production too, such as land. The producers of goods and services are labelled ‘firms.’ Firms and households are in a twin ‘demand and supply’ relationship with each other. First, in the top part of the diagram, households demand goods and services, and firms supply goods and services in the process, exchange takes place. In a money economy, firms exchange goods and services for money. In other words, money flows from households to firms in the form of consumer expenditure, while goods and services flow the other way- from firms to households. This coming together of buyers and seller sis known as a market-a street market, a shop, an auction, a mall-order system or whatever. Thus we talk about the market for apples, for oil, for cars, for houses, for televisions, and so on. Second, firms and households come together in the market for factors of production. This time the demand and supply roles are reserved. Firms demand the use of production owned by households.- labour, land and capital. Households supply them. Thus the services of labour and other factors flow from households to firms, and in exchange firms pay households money- namely, wages rent, dividends and interest. Just as we referred to particular factors markets-the market for bricklayers, for secretaries, for hairdressers, for land, and so on. There is thus a circular flow of incomes. Households earn incomes from firms and firms earn incomes form the households. The money circulates. There is also a circular flow of goods and services factor services to firms who then use them to supply goods and services to households. Microeconomics is concerned with the composition of the circular flow: what combinations of goods make up the goods flow; how the various factors of production are combined to produce these goods; for whom the wages, dividends, rent and interest are paid out. Macroeconomics is concerned with the total size of the flow and what causes it to expand and contract.