Understanding the Circular Flow Model in Economics: Definition and Factors of Production

Written by MasterClass

Last updated: Aug 26, 2021 • 4 min read

The economy can be thought of as two cycles moving in opposite directions. In one direction, we see goods and services flowing from individuals to businesses and back again. This represents the idea that, as laborers, we go to work to make things or provide services that people want.

In the opposite direction, we see money flowing from businesses to households and back again. This represents the income we generate from the work we do, which we use to pay for the things we want.

Both of these cycles are necessary to make the economy work. When we buy things, we pay money for them. When we go to work, we make things in exchange for money.

The circular flow model of the economy distills the idea outlined above and shows the flow of money and goods and services in a capitalist economy.