A Simple Economy model, presents the economy where all the income is spent on goods and service. Here there is no representation of out flow of return from goods and services separately. The total output income is generated from the good and services and returns to spend again for goods and services. This is a very basic model of explanation of economy, which did not consider the other factors or elements of economy.
The other model of economy called Circular flow of economy model has much inputs to explain the flow of economy by including more elements of expense and payments.
Among all other economy models the Circular Flow macroeconomic model is considered as the most simple model. The term circular flow of income or circular flow in economy refers to a simple economic model that has the reciprocal circulation of income between consumers and producers. This model explain the inter dependent entries of producer and consumer. The circular model presents the companies as producers and the “households” as the consumers.
The circular flow model explains the economy flow as the complete flow of income. Companies provide consumers with goods and services in exchange for the money spent by the consumer and the “factors of production” from households.
The money flows in a circle in this economy model as follows: The total income is spent on goods and service by way of purchasing. The money in savings is considered as the leakage in circle flow of money. This income is again paid by the firms to the employees as wages and salaries. The expenditure as a way of interest on existing wealth is considered as “injections” which can be added to total spending by the firms.
This way leakages equal injections to bring it to equilibrium and this makes the monetary system to stay at the same size. If injections are excess to leakage, the economy shows prosperity by showing up a growth in the circular flow. If the leakages are excess then the circular flow shrinks; then the economy experiences a recession. The resources (employees, goods) purchased by firms are then used to again produce goods by the firms.
The Circular flow model of economy the flow of income by way of income and expenditure is influenced by the decision makers choice on how, what and for who to produce the goods and services.
There are many such decision making players in the built of this economy model. Some of them are Households and firms, markets, goods markets, factors markets etc.,
The individuals and group of people will make decisions on the buying choices. The factors of production are the direct resources for production and the goods and services are the buyers from them.
Firms are the units that organize the production of Goods and Services.
Market is the place or the arrangement that pulls the sellers and the buyers together to coordinate the trade and money flow activity. This can be off two types: Goods market where goods and services are sold and purchased. Factor market is where productions of the market are sold and purchased. These markets are associated with Price and demand.
Price is the essential means of communicating the value of the goods or services in the market. When products are sold at higher prices, it signals the demand of the product in that particular market. On the other hand, the low price indicates the low demand of the product from the consumers.
Also if the production is high for particular goods the demand can be less, whereas if the production is less, sometimes the demand for the goods can be high. In other terms, when goods are produced low, the prices go up encouraging the producers to produce more.
The effect of Demand: An increase in price will cause a decrease in quantity. A decrease in price will cause an increase in quantity demanded.
The change in price occurs when there is a change in quantity or demand. This when presented as a graph can be represented as demand curve. There are certain determinants of demand which causes alterations in Demand. Such demand determinants will cause a shift in demand curve.
There are certain determinants of the demand in the circular flow that cause change price and demand. They are, Number of buyers, Income effect, Prices of Substitute Products, Prices of Complimentary Products, Consumer Preferences, Consumer expectations.
So the demand has determinants like – income, price, taste, cost of raw material or source goods, number of buyers, expected prices, etc.
When the Number of buyers is more the demand will be more and when the number of buyers are less the demand will be less and the flow of income into economy will be less.
When the Income effect is derived from normal product, there will be increased demand.
For inferior products, the demand will be decreased when there is an increased income.
The price of substitute products will shift the price or demand levels of the out put. The price increase of the substitute product will either decrease or increase the demand.
Also the prices of the complimentary products will also decrease or increase the demand and price levels of the products and hence the income flow in to the economy.
The consumer preferences and tastes defer the demand levels. The same way consumer expectations also alters the income and demand levels into the economy.
J. Bradford DeLong, The Circular Flow of Economic Activity, Retrieved February3, 2009,
Circular Flow, Retrieved February3, 2009,
Damand And Supply: The Working of the Market, Retrieved February3, 2009, from http://www.oswego.edu/~atri/lac/lec3e200.htm
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