Question
Explain the Circular Flow Diagram of the aggregate economy. Start from Households, then to Firms, then to Government, and then the Rest of the World Explain the Circular Flow Diagram of the aggregate economy. Start from Households, then to Firms, then to Government, and then the Rest of the World
Answer
Step 1
Circular flow model explains how an economy functions. It analyses the way goods, services and money flows in an economy.
Step 2
Significant participants of four sector model include households (consumers), companies (producers) the government, and rest of world.
Household sector: The household sector offers services to companies in exchange for monetary compensation. As a consequence, money flows from companies to households. Furthermore, they buy goods from companies, resulting in money moving from the household sector to the business sector.
Firms in the private sector: These firms receive services from the household sector and pay salaries. Furthermore, these companies make money by selling goods to the private and public sectors.
Government sector: The government levies taxes on companies and individuals; as a result, money flows from businesses and individuals to the government.
Households receive transfer payments from the government, and companies receive subsidies. Money flows from the government sector to households and businesses in this area.
Rest of world: The home country imports the foreign commodities and services.
Firm’s purchases raw material which is not or less available in the domestic country.
So, money transfers from domestic country to the foreign. When the goods and services are produced in the country and is exported to rest of world, the money
flows from rest of world to the domestic country. Hence, in this way money flows from domestic country to rest of world in cicular fashion.
