The circular flow diagram is an eco

The circular flow diagram is an economic model that shows how the household, firms, government and overseas sectors are interrelated, and are all interdependent on each other. Real (physical) flows in the model are factors of production (resources) and goods and services. Money flows in the model are those that finance the flows of resources, goods and services. The model is based on several assumptions. We group consumers into households and assume that households own all resources. We group producers into firms.

The two sector circular flow model shows the relationship between the household and firm sectors. The real flow of resources (inputs) owned by households are used by firms to produce goods and services. Firms pay households' incomes (Y) for the resources they supply. Households use this income to purchase the goods and services they desire from firms, this is termed consumption spending (C).