The circular flow of income in a simple economy where all income is consumed
The operation of forces in an economy can be expressed in the form of a circular flow of incomes and spending between households and firms. A household is a group of people (consumers) earning incomes and spending them on goods and services produced by the firms. Money passes from households to firms in return for goods and services produced by firms and money passes from firms to households in return for factor services provided by households. The simple notion that the money value of the income of households must equal the money value of output of firms and the money value of household expenditures to purchase this output provides the basis for national income accounting.
In this simple economy we assume that the household spends all income. This spending on consumer goods (termed consumption (C)) is the only component of aggregate demand (AD) in this simple economy.
This economy is in
equilibrium because: Y = AD
Y = C
If Y is greater than C, Y will fall; if Y is less than C, Y will rise.