![]() ![]() ![]() This is shown in the inner circle and represents the two sides of the labor market in which households supply and firms demand. Households sell their labor as workers to firms in return for wages, salaries and benefits. This is shown in the outer circle, and represents the two sides of the product market (for example, the market for goods and services) in which household's demand and firms supply. In the diagram, firms produce goods and services, which they sell to households in return for revenues. The circular flow diagram simplifies this to make the picture easier to grasp. Also, not shown in this simple illustration of the economy are other aspects of economic activity such as investment in capital (produced-or fixed-assets such as structures, equipment, research and development, and software) and flows of financial capital (such as stocks, bonds, and bank deposits). An economy involves interactions between not only individuals and businesses, but also Federal, state, and local governments and residents of the rest of the world. The total economy is much more complicated than the illustration above. In the real world, there are many different markets for goods and services and markets for many different types of labor. That income is, in turn, spent on the goods and services businesses produce. Businesses provide individuals with income (in the form of compensation) in exchange for their labor. ![]() Alternatively, one can think of these transactions in terms of the monetary flows that occur. These activities are represented by the green lines in the diagram. In this simple economy, individuals provide the labor that enables businesses to produce goods and services. To better understand the economy and the NIPAs, consider a simple economy consisting solely of businesses and individuals, as reflected in the circular flow diagram (1) :įigure 3-1: The Circular Flow by The Bureau of Economic Analysis is licensed under Public Domain. The circular flow diagram pictures the economy as consisting of two groups - households and firms - that interact in two markets: the goods and services market in which firms sell and households buy and the labor market in which households sell labor to business firms or other employees. ![]()
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