Circular Flow diagram

Definition

The circular flow diagram is a visual representation that shows how money and goods/services flow between households and firms in an economy.

Analogy

Imagine a game of catch between two friends. One friend throws a ball (money) to another friend who catches it and throws it back. The circular flow diagram is like this game of catch, showing how money continuously moves between households and firms in an economy.

Related terms

Household Sector: This term refers to all individuals or groups living together under one roof who make consumption decisions in an economy.

Firm Sector: This term refers to all business organizations that produce goods or services in an economy.

Leakages and Injections: These terms refer to economic activities that disrupt or add extra flows into the circular flow diagram, such as savings (leakage) or government spending (injection).