The Circular Flow of Income


To help understand how money flows through an economy, we can start by looking at an economy that only has two groups of people: households and firms.


ґ Households make up the people that live in a country. They own all of the economic resources in the economy: land, labour, capital and enterprise.


ґ Firms are businesses that people set up to produce goods and services.


Firms pay households to use their resources (they own the land, labour, capital and are the enterprise) to produce goods and services. Households use the income received from firms to buy their goods and services.


For example, an employee (the household) gets paid a wage by their employer for providing labour. They then spend some of their income on the goods and services in different shops (the firms).


f i


This creates a simple loop: firms pay households for providing economic resources (land, labour, capital, enterprise) and households then spend some of their income buying goods and services that firms produce. Firms then earn more money and pay for more economic resources from households. Money flows from firms to households and back to firms and around again.


314 2


eh


o


Households spend their income on goods and services of firms


Firms pay households for providing their resources


m s


h


o u


s


d s


l


r


STRAND 3


CHAPTER 28: The circular flow of income


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