Circular Flow Model in Economics: Definition & Examples

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  • 0:02 What Is the Circular…
  • 1:10 Examples of a Circular…
  • 2:34 Lesson Summary
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Lesson Transcript
Instructor: Jarvista Rivers

Jarvista has an MBA and a BS in business administration.

The circular flow model in economics is critical for thriving societies. In this lesson, we will learn about this simplified view of how our economy moves and what causes this continual movement.

What Is the Circular Flow Model?

The circular flow model in economics describes how resources, money, goods, and services flow through an economy. In order for economies to thrive, there must be movement, energy, and life. Goods and services are only as valuable as the ability to create, purchase, and use them. Therefore, the circular motion shows the flow of money to households then into goods and services and back into households. When people are not spending due to a lack of money or credit, this creates stagnation in the circular flow.

High performing economies move in a circular motion to ensure the movement of money or credit is available to produce goods and services. Our labor, skills, talents, and signatures are the most valuable assets in the circular flow model. It provides the credit for which money is created to maintain the movement of goods and services. This money is then used for purchases, production of goods and services, and to create new business ventures. As new business ventures grow and evolve, this increases job opportunities, therefore, creating a greater demand for more labor, skills, and talents.

Examples of a Circular Flow Model

George, the entrepreneur, opens a restaurant. How will he fund this venture? It starts with his signature on a line of credit. This line of credit creates the money. This money in the form of a check or loan is now deposited into the bank so that George can begin to purchase goods and materials for his restaurant. Based on this deposit and through a system known in banking as fractional reserve, the bank now increases its credit power and can extend it to others. As for George, this allows for job creation and new services for his restaurant.

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