The Circular Flow of Income and Expenditure

This is an economic model illustrating the flow of payments and receipts between domestic firms and domestic households. The households supply factor services to the firms. In return, they get factor incomes. With factor incomes, they buy goods and services from the firms. These flows can be illustrated diagrammatically as follows:

The points at which flows from one sector meets the other sector and generate other flows are called critical points. In the above diagram, the critical points are A, B and C. At A, the flow of factor services from the households sector meets the firm sector and generates the flow of factors incomes from the firms to the households. At B, the flow of factor incomes meets the household sector and generates the flow of consumer spending. At C, the flow of consumer spending meets the firms sector and generates the flow of goods and services.